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Investing in Retirement Funds

Typical Retirement Account Vehicles

Investing in specially created retirement accounts can be tax advantageous for investors. Specially created retirement accounts include IRAs, Roth-IRAs. 401(k)s, SEP-IRAs, and Keogh plans. The tax advantage in these accounts that may not be available to investors outside the accounts is that money inside one of these protected accounts grows without being taxed. The only time you pay income tax on these accounts is when you withdraw money. It should be noted that transfers to other retirement accounts are often called rollovers, and are not taxed as a withdrawal.

The most noticeable benefit of this tax advantage is that there is more money in your account which can be compounded. Compounding is a financial principle that is best explained as all of the money you earned that year is used to calculate your returns for the following year. This helps your fund grow faster than if there is no compounding. As an example, if you start with $ 10,000 and earn 10% the first year, and 10% the second year, under the simple interest theory you have $ 11,000 the first year and $ 12,000 the second year. With compounding, you have $ 11,000 after the first year, and $ 12,100 the second year. This extra $ 100 does not sound like a lot, but by the time years 10 and 20 roll around the effect of that extra money added in each year from the previous years, it can mean a difference of thousands of dollars.

Individual Retirement Accounts – IRAs

To stimulate investing among private citizens, Congress created a vehicle for private investing in a tax-free until withdrawal program called an IRA. This enabled individuals to save up to $ 2,000 per year, free of income taxes, in a specially created IRA account.

Recently, Congress altered the IRA rules to create the Roth-IRA. This changed several of the mechanical rules for certain individuals up to certain income levels. However, the concept is essentially the same. We are deliberately avoiding setting forth the specific rules here, since it is likely they will change again in the near future. It is easy to find the IRA or Roth-IRA rules and these can be read if necessary. It should be noted that distributions can begin at age 59 ˝ and must begin by age 70. This means that at the latest, plan on some taxable income by age 70, if you establish an IRA. Another limitation of an IRA, although this has been modified somewhat by the Roth-IRA rules, is that distributions taken before age 59 ˝ are taxable at the rate of 10% over and above your taxable income.

What is most important is that each investor can save a certain amount of income, tax-free until withdrawal. You ought to review your financial planning goals to determine if this type of investment is right to meet your goals. Also, do not overlook the fact that you might have several retirement investment vehicles to help you achieve your goals, and this IRA, in some form, will likely be at least one of the vehicles you utilize to achieve these goals.

Also, there are many options available to you for investments with the money placed into an IRA, including all stocks, bonds and Mutual Funds. However, before making a final decision as to your particular investment, check the current rules to make certain your investment is appropriate for an IRA.

Employer-Sponsored Plans – 401(k)s.

Many for-profit companies offer 401(k)s which is a retirement account that allows you to invest money up to certain limits which change based on the current tax law, it was $ 9,500 for 1997. The amount may also be limited by the pool of investment income of your company’s employees. Professional advice or help from your employer can help you understand the mechanical rules applicable in the year of tax filing relevant to your case.

In addition to the tax saving benefit, there is an incentive for an employer to contribute matching funds to your retirement account. Again, this is subject to specific company benefits and the plan advisor can help in this regard. The spread of mutual funds has helped smaller companies create 401(k)s, which were, in the past, unavailable to smaller companies. The larger mutual fund families may be of assistance in helping your company establish or administer a 401(k) plan.

401K(k)s can invest in a number of classes of assets, if they are set up in this manner. Typically, each employee is permitted to select from a few investment choices, depending upon their own needs and financial goals. Usually a management company is hired by the firm to manage the selections and to maintain accurate payroll records. The trend has been for the federal government to allow employees more choices in their own investments within the 401(k) plan. This has the effect of allowing employees to utilize their own financial planning goal analysis, or the analysis performed by a financial planner to meet the established goals of that employee, without regard to what other employees are doing.

All of the contributions you make to a 401(k) are yours, and are not able to be taken back or "held over your head" in any manner by any employer. Additionally, any contributions made which match your contributions are also yours, subject to plan terms regarding vesting. Vesting is the expiration of certain time limits with that employer making the contributions before the money actually becomes yours to keep, if your are terminated, or you leave on your own. The vesting rules are set by law and are usually designed to give some consideration to the employer's need to keep employee from "running off" and the employee's need to leave a job for a better one elsewhere.

Money from a 401(k) is straightforward in most cases., although the tax consequences are extremely detailed in the Internal Revenue Code. Tax professionals should be consulted if you are your family has a 401(k) distribution issue, prior to taking any distribution.

The non-profit company version of a 401(k) is the 403(b) plan. These are usually administered by insurance companies. They have certain special rules and a professional ought to be consulted if they apply to you or your family’s situation.

Self-employment Plans – SEP-IRAs.

Since self-employed people do not have an employer, they could not create a retirement plan, unless Congress provided a special program for them. Indeed, it has in the form of the SEP-IRA. If you are self-employed, there are very strict rules against neglecting to provide for the retirement funds of your employees, including a disallowance of the income tax advantages from previous years. It is wise to consult with a tax-professional in this area, if it applies to you.

Keoghs

Keoghs are complicated retirement funds for self-employed individuals, and are more difficult to administer than SEP-IRAs but allow you to contribute more income tax-free. These have even more complicated rules and ought to be avoided without professionnal assistance.

Investing in Retirement Funds
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