Traditional Individual Retirement Accounts
You can set up a traditional IRA with your bank, credit union, broker or other financial institution. Contributions for a given tax year are deductible, and can be made between January 1 of the tax year and April 15 of the next year. Any withdrawals you make will be taxed as ordinary income.
In addition, the IRS will slap you with a 10% penalty for withdrawals before age 59 1/2, unless you qualify for a handful of exceptions. You must begin taking required minimum distributions (RMDs) by April 15 of the year after you reach age 70 ½. RMDs are based on your account balance and your life expectancy (as figured by the IRS).
If you set up a self-directed IRA, you can use it to purchase just about any kind of asset, except for insurance and collectibles (stamps, art, antiques, playing cards, etc.). You’re also allowed to purchase certain types and forms of precious metals.
Companies such as Swell Investing can help you find the perfect retirement account for you. They find the best options in your area.
Here are the limits on traditional IRAs for 2019:
- Contributions: up to $6,000 of your taxable earnings. If over age 50, you can make an addition, catch-up contribution of $1,000
- Deductions: you can deduct your full contribution. However, if you’re also enrolled in a qualified retirement plan at work, your deductions are phased out starting at a modified adjusted gross income (MAGI) of $64,000 for single filers and $103,000 for joint filers. If only your spouse is covered at work, your phase out as a joint filer begins at $193,000
A Roth IRA is similar to a traditional IRA, except for these items:
- Contributions aren’t deductibles
- Withdrawal of contributions are always tax-free
- Withdrawals of earnings can be tax free, if you’ve reached age 59 ½ and your earliest contribution occurred at least five years previous. Otherwise, you must pay tax on the withdrawal, and you may have to pay the 10% penalty unless you qualify for an exception
- There aren’t any required minimum distributions
- Your ability to contribute is phased out as your MAGI rises. For 2019, contributions phase out at $122,000 for single filers, and are prohibited starting at $137,000. For joint filers, the MAGI limits are $193,000 and $203,000, respectively
The Simplified Employee Plan (SEP) IRA is a workplace plan for self-employed individuals and owners of small businesses (no more than 100 employees).
They’re traditional IRAs except for the following:
- Only the business owner can make contributions on behalf of employees. The 2019 contribution limit per employee is the lesser of 25% of total compensation and $56,000
- There’s no catch-up contribution
A SIMPLE (Savings Incentive Match Plan for Employees of Small Employers) IRA plan is another workplace plan similar to a traditional IRA. However, contributions can be made by the employee and by the employer. Employer contributions can be matching contributions or nonelective contributions. For 2019:
- Employees can contribute up to $13,000 of their salary. If the employee participates in another employer plan during the year, the total contribution limit for all plans is $19,000
- Employees age 50 and above can make a catch-up contribution of up to $3,000 in 2019
- Employers can match up to 3% of employee contribution. The amount can be less, but must be no less than 1% and for no more than two out of the last five years
- Employers can instead make nonelective contributions of 2% of employee compensation (up to $280,000 in 2019) for each participating employee, whether the employee makes any contributions or not
Qualified Employer Plans 401(k) and 403(b)
The two main types of qualified employer plans are the 401(k) plan (for most employees) and the 403(b) plan (for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers). Both plans operate under ERISA regulations. You can have traditional and Roth accounts in these plans. These are the limits for 2019:
- Employee contributions: Up to $19,000 of your taxable earnings. If over age 50, you can make an additional, catch-up contribution of $6,000.
- Employer contributions: Employers can contribute matching or profit sharing amounts such that the total annual addition to an employee’s account doesn’t exceed $56,000 (or $62,000 with the catch-up contribution).
- Withdrawals: Before age 59 ½, withdrawals generally are allowed only through a distribution event. These include terminating employment, discontinuance of the plan and becoming disabled. The employer might also allow loans and withdrawals due to financial hardship. The list of exceptions to the 10% early withdrawal penalty is slightly different from the IRA list.
- Withholding: withdrawals before age 59 ½ are subject to 20% withholding by the employer unless you arrange a direct rollover to another employer plan
- Required minimum distributions: begin in the year after you reach age 70 ½, unless you continue to work for the employer and you are not the business owner. The RMD requirement also applies to Roth accounts
Tax Advantaged Nonqualified 457 Plan
The 457 plan is an employer plan for state and local public employers and some nonprofit employers. Its nonqualified and not subject to ERISA rules, but is tax-advantaged and generally follows the same rules as a 401(k) account. However:
- A 457 plan does not assess a 10% penalty for a withdrawal before age 59 ½
- It allows certain employees to make up to $19,000 in catch-up contributions, for a total employee contribution of up to $38,000 in 2019
- Hardship withdrawals are permitted after an “unforeseeable” emergency
- Independent contractors can participate in the 457 plan