Last week we answered a question regarding IRA's, here is additional information regarding contributions to 401k's and Roth Ira's.

401 (k)s

A 401(k) plan is an employer-sponsored plan that lets you contribute a percentage of your salary to a trust account, putting off any taxes on that money until you withdraw it, usually after age 59 1/2. Companies often match some of your contribution, and any taxes on those matching funds are also deferred, as long as the total going into the account does not exceed the limit for the year. Like with IRAs, the earnings in the account grow, tax free, until you withdraw the money, and if you expect your tax rate to drop after your retirement, because you have less income, your savings could amount to an even bigger nest egg.

Through automatic payroll deductions, you can usually contribute between 1 percent and 25 percent of your eligible pay on a pre-tax basis, up to the annual IRS dollar limit of $11,000 ($12,000 if you're age 50 or older). In this case, you are making salary-reduction contributions that reduce your take home pay, but also your income tax basis, a significant tax break vs. "after tax" investments.

There are typically IRS penalties associated with early withdrawal of 401(k) assets, but many plans allow you to borrow against your assets. If you leave an employer, you may be able to keep your plan with the employer, or "roll it over" into an IRA, avoiding these penalties. Consult your plan administrator for details.

Twenty percent Withholding on Distributions from Qualified Employer Plans

Income tax withholding may apply to distributions made from qualified employer plans. Withholding at a rate of 20% is required on a distribution, unless it is transferred directly from your employer to an IRA trustee or another employer plan. The withholding rules do not apply to distributions from IRAs or Simplified Employee Pensions, also known as SEPs. However, if you wish to rollover a qualified plan distribution to an IRA, be sure to transfer the amount directly from your employer to an IRA trustee or another employer plan. Otherwise, 20 percent of the distribution will be withheld while 100 percent of the distribution must be rolled over within 60 days. If you don't have the money to cover the 20% shortage, income taxes and possibly a 10 percent penalty will be due on the amount not rolled over.

ROTH IRA. A ROTH IRA, is in some respects the opposite of a traditional IRA: You pay taxes on the money that you put into the account up front, but once you reach age 59 1/2, (after having had the Roth IRA for five years), you can withdraw the money, including interest earned, tax free.

For some people, paying taxes now to enjoy tax-free income later may actually make more financial sense in the long term. For one thing, the Roth IRA lets you shelter more money for retirement. The annual contribution limit is the same for both a traditional IRA and a Roth IRA, but because your Roth contribution is made with after-tax income, your annual contributions can compound substantially over the years without incurring any future tax liability.

Whether the Roth IRA is a better option really depends on what you think your future tax rate will be. If you plan to maintain a high levels of income even in retirement, it may make more sense to pay taxes on your contribution today, while you're still employed, so you can enjoy the tax-free withdrawals later.

To contribute to a Roth IRA, you must have compensation (e.g., wages, salary, tips, professional fees, bonuses). Your modified adjusted gross income must be less than:

$160,000 Married Filing Jointly

$10,000 Married Filing Separately (and you lived with your spouse at any time during the year)

$110,000 Single, Head of Household, or Married Filing Separately (and you did not live with your spouse during the year).

If you would like more information or would like to ask a question, please contact Frederick Hubler at or call 610-560-2003. Frederick Hubler is an award winning financial advisor and is president of Creative Capital Solutions, a private financial planning company in Chester County specializing in helping clients acquire, protect and transfer wealth. . Securities offered through Capital Analysts Incorporated Member NASD; SIPC.

comments powered by Disqus