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IRA v. 401(k)-?

Posted on March 18, 2014 by Dr. David Edward Marcinko MBA MEd CMP™

On Retirement Vehicles

By Rick Kahler MS CFP® http://www.KahlerFinancial.com

Which is the better choice for retirement saving, an IRA or a 401(k)? And what’s the difference between the two?

Either an IRA (Individual Retirement Account/Arrangement) or a 401(k) plan is a great place to start investing for retirement. They are more alike than different, and which one to choose depends on your particular circumstances.

Basics

Here are some of the basics you need to know.

1. Who can use these plans?

You can open an IRA if you or your spouse has income earned from working. This includes wages, commissions, and self-employment income but not income from sources like rental property or pensions.

Since 401(k)s are only offered through employers, these plans are not available to everyone. IRAs can only be opened by individuals and are never available through employers.

2. How much can you contribute?

For 2014, the maximum annual contribution for an IRA is $5,500, or $6,500 if you’re 50 or older. The maximum annual contribution for a 401(k) is $17,500, or $23,000 if you’re 50 or older. Spouses eligible to participate in their own plans can each contribute the maximum.

3. Is there employer matching?

With an IRA, no. But many employers match part of employees’ contributions to 401(k) accounts. This is why a 401(k), if available, is often the best place to start your retirement saving. Part of the money you put into the account is doubled even before it earns any kinds of investment return.

4. What about taxes?

With a traditional IRA or 401(k), all or part of the contributions you make are usually tax-deductible but you pay taxes on the money you withdraw at retirement. The money you contribute to a 401(k) is not taxed; it is taken out of your paycheck before tax withholding is figured. Any matching 401k contribution from your employer is not taxed, either. You do pay taxes on the money you withdraw.

If you choose a Roth IRA or 401(k), your contributions are not tax-deductible. However, the money you withdraw after retirement is not taxed.

With both traditional IRAs and 401(k)s, if you withdraw funds from the account before age 59 1/2, you generally have to pay taxes on that money, plus a penalty of 10% of the amount withdrawn.

5. What if you leave a job and have money in a 401(k)?

Any money you have contributed, plus its earnings, is yours. Usually you have to stay with a company for several years before the employer match is fully vested, meaning it’s yours to keep even if you change jobs. You can roll over the amount in your account to an IRA or to a new employer’s 401(k) without paying penalties. This rollover amount doesn’t count toward your annual contribution limit.

6. Is a 401(k) or an IRA a better investment?

This is something that confuses a lot of people. Neither IRAs nor 401(k)s are investments in themselves. Instead, they are accounts, serving as containers to put investments in. A 401(k) plan will usually have several different investment options to choose from. IRAs typically have many more investment options. My advice is to pick mutual funds that include the greatest variety of asset classes like US stocks, international stocks, US bonds, international bonds, real estate, and natural resources. In either an IRA or a 401(k), it’s wise to diversify your retirement funds among as many asset classes as you can.

Assessment

In sum, either a 401(k) or an IRA is a good retirement savings choice. Some taxpayers can contribute to both. What matters most, though, is choosing to make regular contributions to a retirement account in order to provide for your future.

Conclusion

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Filed under: Retirement and Benefits | Tagged: 401(k), individual retirement account, IRA, retirement planning, Rick Kahler CFP® | 1 Comment »

On Employer-Sponsored Retirement Plans

Posted on May 16, 2013 by Dr. David Edward Marcinko MBA MEd CMP™

Should I Stay … or … Should I Go?

By Guy P. Jones CFP® www.guypjones.com

Many ME-P readers may remember the song by the same name released in 1982 by English punk band, The Clash.

If you do and you were in your late 20’s or early 30’s then, you are probably asking the same question about your hospital, medical clinic or employer-sponsored retirement plans, 401k, 403b, 457b and the like, right now.

History

Since the 401k was introduced back in 1978, it has been promoted as the “holy grail” of retirement savings vehicles, mostly by the mutual fund companies that it favors. Since the introduction of the 401k, there has been a gradual, yet steady, decline in employer-sponsored pension plans by private sector employers to the point that they are almost nonexistent.

Unless you work for a very large company or work in the public sector, your pension plan was phased out a long time ago. This has thrust a myriad of decisions regarding retirement planning on a workforce that is ill prepared to make the proper choices as to appropriate investment options. They therefore have relied on their employer to choose for them. In doing so, we now have a retirement system that is fraught with poor performing, high-cost, limited-choice, loss-incurring investment options.

Another Option?

But, wait, what if there was another, better option for some of you? What would you do if you were suddenly handed a “Get Outta Jail Free Card” from your employer-sponsored retirement plan? Well, guess what, you just have! It’s called an “In-Service Distribution” or “In-Service Transfer” to an Individual Retirement Account (IRA).

So what exactly is an In-Service Distribution or In-Service Transfer?

An In-Service Distribution allows workers to empty their 401(k) accounts once they hit 59½. This means that they can take cash out, pay any ordinary income taxes due and spend what’s left. The same goes for participants in government and not-for-profit savings plans like 403b, 457b, and TSP accounts. Or, they can roll all the money into an IRA without paying tax now which is an In-Service Transfer.

Need to Know:

You first have to determine if your employer-sponsored plan even permits in-service distributions or transfers. It is determined by what was written in your company summary plan description.
Many plans permit workers to take out or rollover to an IRA when you reach 59½, but some plans also permit in-service distributions for those under the age of 59½. This permits them to get in-service distributions of money rolled over from previous plans, employer (but not employee) pretax contributions, employee after-tax contributions, and account earnings. If they spend the cash, instead of rolling it over, they will owe an extra 10% penalty on the taxable amount.
In doing an In-Service Transfer, you must make sure the rollover is to an IRA. In doing so, you avoid IRS taxation (and possibly penalties) on this money.
Some plans have already pre-approved this option and in many cases can process the in-service distribution or transfer to an IRA right over the phone. Other plans require the completion of some paperwork which then has to be signed by your employer.

[The Retired Doctor’s Lounge]

What Funds are eligible for In-Service Distributions or In-Service Transfers?

When you decide to rollover money from your current employer-sponsored plan to your own IRA while still employed, here are the funds that will be available, subject to the summary plan description:

Your employer contributions including match and profit sharing
Your personal after-tax contributions
Your pre-tax contributions when you reach age 59½.

Reasons to Do an In-Service Distribution or In-Service Transfer

Unlimited Control — With an IRA, you are the account owner and have more control over your assets, more control over the investment choices, and are free from the restrictions of your employer-sponsored plan.
Diversification — Most employer-sponsored plans offer limited investment options. Conversely, IRAs enable you to choose virtually any investment option including individual stocks, bonds, ETFs, mutual funds, real estate and precious metals. This flexibility can help you better diversify your retirement assets to meet your individual investment goals.
Beneficiary Options — IRAs allow non-spouse beneficiaries to stretch distributions from an IRA over their lifetimes. This type of beneficiary distribution option not only results in greater distributions over their lifetime, but also enables the beneficiary to minimize the taxes owed on the distributions. This is not available in most employer-sponsored plans, which may limit distribution choices for your beneficiaries.
Income Tax Withholding — Employer-sponsored plans have a mandatory 20% withholding tax on any cash distributions from the plan whereas IRAs allow you to choose whether you want tax withheld or not.
ROTH IRA Conversion Option — Since 2010, any one regardless of their income can convert a Traditional pre-tax IRA to a ROTH IRA where future earnings are tax-free. In addition, you are now permitted to roll 401(k) money directly into a Roth IRA. Income taxes would be due, but not the 10% IRS penalty for pre-59½ withdrawals. If you want to do a gradual conversion of your traditional IRA to a ROTH IRA to minimize taxes, this would be another benefit to getting it out of the employer plan into an IRA now.
Required Minimum Distributions — By getting your money out of the employer plan, you can do a conversion to a ROTH IRA to eliminate having to take RMDs starting at age 70½. RMDs affect the taxability of your Social Security benefits and by eliminating them, the taxation on your social security would be reduced.
Protect IRAs from Investment Losses — Generally, what is offered in employer qualified plans are mutual funds which can and will lose money in the event of a market decline. By doing an in-service transfer to an IRA, you can choose options that will protect these funds from investment losses, lock in gains, and create an income stream that you can never outlive.

###

[Physician Retirement Funds]

Drawbacks to doing an In-Service Distribution or In-Service Transfer

Age limitations — with employer plans, they allow participants who stop working at age 55 or older to take distributions without the 10% IRS penalty. In an IRA, you can’t take distributions until age 59½ without incurring the 10% penalty. If you plan to retire before age 59½, you may want to preserve penalty-free access to your retirement funds by not moving all of your 401(k) assets to an IRA before retirement
Net Unrealized Appreciation (NUA) — tax treatment is not an option for distributions from IRAs. Therefore, if you hold highly appreciated company stock in your employer-sponsored plan, the transfer of that stock to an IRA eliminates any ability you may have to take advantage of NUA tax treatment.
Creditor protection — while IRAs now have federal bankruptcy protection, other IRA creditor protection is still determined by state laws. Texas affords unlimited bankruptcy protection of IRA assets from creditors. Qualified plan assets continue to have broad federal creditor protection.
New contributions to your existing plan — taking an in-service distribution may affect your ability to contribute to your employer-sponsored plan. Be sure to consult with your plan provider or employer HR department before implementing this.
Cost — fees related to having your own IRA could be more costly than the investment options inside the 401k, although this can be controlled by careful selection of IRA options.
After-tax dollars — after tax dollars are generally segregated in a qualified plan, and can often be distributed separately. If you move after-tax money into an IRA, that money becomes part of the non-deductible “basis” of the IRA and will not be separately accessible. To avoid paying tax again on your IRA “basis” when you take an IRA distribution, you must maintain careful records of the “basis” in your IRAs. This can become more of an issue in regards to doing a Roth IRA Conversion.
Loans — loans are permissible through your employer plan, generally up to 50% of the account balance not to exceed $50,000. These loans can be paid back over a 5 year period or 10 years if used to purchase a home. Loans are not permitted in IRAs or ROTH IRAs.

Assessment

So, if this is so great then why doesn’t everyone take advantage of doing an in-service distribution or in-service transfer? The biggest reason is that employers don’t want plan participants to know about it or exercise this option. The second reason is that people don’t understand it or think that by transferring money out of their plan, they will incur tax and/or penalties. Make sure you go through the facts with a professional or your 401(k) company to understand the rules.

Nobody can be certain when the next market meltdown will be. With many Boomers now approaching retirement, you have to keep your eye on what will be the bulk of your retirement assets.

For my part as a financial professional, if your plan allows in-service distributions or transfers and you were debating whether to get out of your employer plan, I would give you the same advice that Jennie gave Forrest Gump when he was being chased by the bullies: RUN FORREST, RUN!!

The Author

Guy P. Jones & Associates

21 Stone Creek Place
The Woodlands, TX 77382
832-677-1692
281-605-5370 fax

Conclusion

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Filed under: Retirement and Benefits | Tagged: 401(k), 403(b), 457b, bonds, Employer-Sponsored Retirement Plans, ETFs, Guy P. Jones, In-Service Transfer, individual retirement account, IRA Conversion Options, Mutual Funds, precious metals., real-estate, Required Minimum Distributions, stocks, TSP accounts | 1 Comment »

When A Regular IRA is Better than ROTH

Posted on July 31, 2012 by Dr. David Edward Marcinko MBA MEd CMP™

More on IRAs for Doctors www.schwartzaccountants.com

By Andrew D. Schwartz, CPA

Each winter, when my staff and I meet with our physician and other clients to review their tax information, we get this question a lot, “Should I go with the Roth version of my employer’s 401(k) or 403(b) plan, or should I stick with the traditional version?”

Taxpayers first had the option of contributing money to a Roth account back in 1998. Remember, when you contribute money to a Roth account, you elect to forego a current year tax break in exchange for a promise from the government that distributions taken from the Roth account down the road won’t ever be taxed.

Through 2005, the only access you had to these tax-free accounts was to contribute to a Roth IRA. Many middle-income and high-income taxpayers never had the opportunity to contribute to a Roth IRA, however, since their incomes exceeded the relatively modest threshold based on their filing status. (The Roth IRA threshold for 2012 is $125k for single individuals and $183k for married couples.)

What Congress Likes

Congress liked that people were giving up a current year tax break by opting to go with a Roth IRA instead of to a Traditional IRA, so decided to expand this opportunity to 401(k) plans and 403(b) plans. As we wrote in our October 2005 Newsletter in an article called The New Roth 401k and 403b, employers could begin to offer the Roth version of these plans as of January 1, 2006.

What’s the difference between the Traditional and Roth versions of these popular retirement savings plans? With the traditional 401(k) or 403(b) plan, the salary deferrals you make reduce your taxable salary and grow tax deferred. You will then owe income taxes on distributions taken from these accounts when you retire.

Example:

As a doctor, let’s say you earn $200k, and you max out your 403(b) salary deferrals for $17k during the year. In this case, your W-2 will report taxable wages of $183k in Box 1. Assuming you are in the 33% federal tax bracket, the $17k you contribute into your 403(b) plan saves you $6,667 in federal income taxes. That’s a pretty good tax break I would say.

What happens if you instead decide to go with the Roth version of the 403(b) plan for your salary deferrals? When you contribute money to a Roth account, you forego a current year tax-break. Your W-2, therefore, will report the full $200k as taxable wages in Box 1, instead of $183k that would be reported had you gone with the Traditional 403b. The benefit of giving up this tax break is the tax-free treatment of the compounded growth on the $17k of salary deferrals. In other words, you won’t owe any federal income taxes on the distributions taken from this account when you retire.

The Max Factor

When my clients ask me for advice about the Roth 401k or 403b plan, I immediately look at Box 12 of theirW-2 forms to see how much they contributed in salary deferrals during the prior year. According to the instructions of the W-2 form, here are the relevant codes that show up in Box 12 of the W-2 form:

Code D – Elective deferrals to a section 401(k) cash or deferred arrangement. Also includes deferrals under a SIMPLE retirement account that is part of a section 401(k) arrangement.

Code E – Elective deferrals under a section 403(b) salary reduction agreement

Code AA – Designated Roth contributions under a section 401(k) plan

Code BB – Designated Roth contributions under a section 403(b) plan

What I’m looking to see is whether this client is maxing out their salary deferrals during the year. If a client is contributing to the Roth version of the 401k and 403b plan, and is falling short of the $17k max ($22.5k max if 50 or older), I strongly suggest that they consider contributing only to the Traditional version until they are able to max out their contributions.

Assessment

In my opinion, socking away as much money as possible each year into these tax-advantaged, creditor protected accounts takes priority over worrying about saving taxes later. Remember, if money is tight, you have the choice of contributing $10,333 into a Roth 401k account, or taking advantage of the $6,667 tax break offered by traditional 401k plans and putting away the max of $17k into the Traditional 401k account.

I think a financial planning twist on Alfred Lord Tennyson’s poem about lost love sums this up best, “Tis better to save and be taxed than never to have saved at all.”

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Filed under: Investing, Retirement and Benefits, Taxation | Tagged: 403-b plans, Andrew D. Schwartz, CPA, individual retirement account, IRA, physician retirement planning, SEP-IRA, When Regular is Better than ROTH | 3 Comments »

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