401(k)s & IRAs For Dummies E-Book

Ted Benna

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 549

Veröffentlichungsjahr: 2021

Beschreibung

From the basics down to investing, get the most out of your 401(k) and IRA in any economic environment When you're ready to start setting aside (or withdrawing) money for your retirement--whenever that might be--401(k)s & IRAs For Dummies is here for you! It covers both types of retirement plans because they each have valuable tax benefits, and you may be able to contribute to both at the same time. With the practical advice in this book, you learn how to manage your accounts, minimize your investment risk, and maximize your returns. Sounds like a win-win, no matter your situation or where you're at in life. Written by a well-known expert and 'father of the 401 (k)' , Ted Benna, 401(k)s & IRAs For Dummies helps you keep up with the ever-changing rules surrounding both retirement plans--including the rules from the SECURE and CARES Acts--and avoid the mistakes that can lead to higher taxes and penalties. Additional topics include: * Tax strategies before and after retirement * Required distributions and how much you need to take * Penalties for taking money out early and how to avoid them * What happens to your or your spouse's retirement plan after death or divorce * The rules for taking money out of an inherited plan * Methods for calculating required minimum distributions * Special tax benefits for conversions to Roth IRAs * How to recharacterize IRA or Roth contributions * Why IRA based plans are a better options for many small employers * Helping solo entrepreneurs and other small businesses pick the right type of plan Whether you're just starting to think about a retirement plan, planning when to retire, or you're facing retirement, you'll find useful and practical guidance in 401(k)s & IRAs For Dummies. Get your copy today!

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401(k)s & IRAs For Dummies®

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401(k)s & IRAs For Dummies®

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Table of Contents

Cover

Title Page

Copyright

Introduction

About This Book

Foolish Assumptions

Icons Used in This Book

Beyond the Book

Where to Go from Here

Part 1: The ABCs of 401(k)s and IRAs

Chapter 1: Explaining IRAs and 401(k)s

Exploring the Basics of Retirement Savings Plans

Comparing and Contrasting IRAs and 401(k)s

Accentuating the Positive

Chapter 2: Taxing Issues

Realizing the Reasons for Tax Breaks

Talking Tax Terms

Getting Credit for Contributions

Taxing Income at Retirement

Staying Alert to Changes in Tax Law

Chapter 3: Naming Beneficiaries and Planning for the Future

Deciding Who Gets Your Savings When You’re Gone

Detailing the Distribution

Talking Timing and Taxes

Passing along Company Stock

Starting the Roth Clock

Qualifying Your Charitable Giving

Being a Beneficiary

Part 2: 401(k) Basics

Chapter 4: Checking the Benefits of a 401(k)

Realizing What a 401(k) Does for You

Vesting: When Your Employer’s Contribution Is Yours to Keep

Letting the Pros Work for You

Protecting Your Money

Watching Out for Potential Pitfalls

Chapter 5: Signing Up for a 401(k)

Exploring Your Eligibility

Making Your Entry Date

Deciding How to Invest Your Money

Chapter 6: Paying Attention to Administrative Issues

Figuring on the Fees

Considering Funding Issues

Knowing What You Can Know

Working to Improve Your Plan

Chapter 7: Weighing Your Options When You Leave Your Employer

Taking Your Savings with You

A Rolling 401(k) Gathers No Taxes

Leaving Money with Your Old Employer

Taking a Lump Sum

Taking Stock into Account

Part 3: Here Come the IRAs

Chapter 8: Investing in an IRA

Looking at the Basics of Your IRA

Setting Up Your IRA

Maintaining Your IRA

Moving Your IRA

Chapter 9: To Roth or Not to Roth

Predicting Future Tax Rates

The “Or Not to Roth” Section

Taking Money Out of Your Roth IRA

Converting to Roth

Chapter 10: Rolling Over an IRA

Rolling-Over Basics (How to Shake Is Next)

Rolling through the Process

Calling a Roth Conversion: No, It’s Not a New Football Play

Paying 20 Percent

Part 4: Saving and Investing

Chapter 11: Setting Up Your Savings Plan

Targeting Your Retirement Date

Getting Your Hands on Your Money

Developing Your Retirement Savings Plan

Chapter 12: Determining How Much to Save

Improving Your Chances of an Ideal Retirement

Deciding How Much of Your Salary to Put Aside

Building Your Nest (Egg)

Chapter 13: Selecting Your Investments

Looking Over the Investment Menu

Forging Your Own Investment Trail

Baking Your Asset Allocation Pie

Seeking Help from the Pros

Chapter 14: Taking Reasonable Investment Risks

Defining Some Investment Basics

Staying In It to Win It

Classifying Different Types of Risk

Understanding the Risk-Reward Relationship

Deciding How Much Risk You Can Stand

Part 5: Money In, Money Out

Chapter 15: Making Contributions

Checking Out How Much You Can Contribute

Maxing Out Matching Contributions

Timing Is Everything

Chapter 16: Withdrawing Money Before You Retire

Taking Money from Your IRA

Accessing Your 401(k) Plan Money While Working

Facing Hardship with Your 401(k) at Your Side

Dipping into Your 401(k) Money to Buy Your First Home

Both a Borrower and a Lender Be

To Loan or Not to Loan (To Yourself, That Is)

Weighing a Hardship Withdrawal versus a Loan

Saying No to Yourself

Chapter 17: Managing Your Plans after Retirement

Looking Forward to Retirement

Decisions, Decisions: What to Do with Your 401(k) Money

Making Withdrawals from Your IRA

Paying Uncle Sam His Due: Required Withdrawals

Developing a Strategy to Deal with the Tax Man

Managing Your Investments in Retirement

Managing Risk

Consolidating Your Accounts

Tending to Your Nest Egg

Row, Row, Row Your Boat, Gently Down the Income Stream

Treating Your Home Like the Asset It Is

Part 6: Helping Small Employers

Chapter 18: Plans from a Small Employer’s Perspective

Putting in the Effort

Meeting Regular 401(k) Requirements Is a Pain in the Pocketbook

Comparing 401(k)s

Finding Alternatives to a 401(k) Plan

A Word about Cost

Chapter 19: Offering a 401(k) Plan

First Things First

Choosing a 401(k) Provider

Choosing Investments and Advisors for Your 401(k) Plan

Wrapping Up a Package of 401(k) Plans

Joining Up: MEPs, PEPs, and PPPs

A 401(k) Is a Terrible Thing to Waste: Educating Employees

Chapter 20: Choosing a Plan for Your Business

Selecting a Plan That’s Right for You

Considering Real-Life Examples

Getting Credit to Set Up

Changing Service Providers

Part 7: The Part of Tens

Chapter 21: Ten + Two Ways to Save For Retirement

Join an Employer-Based Retirement Plan

Set Up Automatic Withdrawals

Start Young

Deposit Bonus Money in Your Retirement Account

Earmark $20 a Week for Your Retirement Fund

Deposit Your Tax Refund into Your Retirement Account

Cancel Subscriptions You No Longer Use

Refinance Your Mortgage

Shop for Better Insurance Rates

Resist Click Bait

Think Before You Spend

Reduce Your Transportation Costs

Chapter 22: Ten Questions about IRAs Answered

Where can I start an IRA?

Do I need to hire a broker or financial advisor to start an IRA?

How much can I contribute to my IRA?

What tax breaks do I get for having an IRA?

How do I take money out of my IRA?

How much tax do I have to pay when I withdraw money from my IRA?

What can I invest in through my IRA?

What’s the safest way to invest my IRA money?

Is my IRA insured?

Can I start an IRA for my spouse and/or children?

When do I have to start taking money out of my IRA?

Chapter 23: Ten Reasons to Participate in a 401(k)

You Can’t Afford Not To

The Stock Market Can Be Your Friend

You May Get Contributions from Your Employer

Your 401(k) Money Is Placed Safely in a Trust

Any Plan Is Better than No Plan

Your Account Is Portable

You May Be Able to Take Out a Loan

Social Security Isn’t Enough

The Younger You Start, the More You Can Save

You Can Contribute More as You Get Older

Index

About the Author

Advertisement Page

Connect with Dummies

End User License Agreement

List of Tables

Chapter 2

TABLE 2-1 2021 Tax Tiers by Income

TABLE 2-2 2021 IRA Deduction Limits

TABLE 2-3 Roth IRA Deduction Limits

TABLE 2-4 Deduction Limits if Spouse Has an Employer-Sponsored Plan

TABLE 2-5 2021 Saver’s Tax Credit Rates

TABLE 2-6 Tax Rates on Social Security Benefits in 2021

TABLE 2-7 Comparing Taxable Income after Retirement

TABLE 2-8 Comparison of 1998 and 2021 Tax Rates

Chapter 4

TABLE 4-1 Take-Home Pay without and with 401(k) Contributions

TABLE 4-2 Longest Allowed 401(k) Matching Contribution Vesting Schedules

Chapter 11

TABLE 11-1 Retirement Age by Birth Year

TABLE 11-2 Reduced Social Security Benefits

TABLE 11-3 Enhanced Social Security Benefits

TABLE 11-4 Ten Tips for Saving Money

TABLE 11-5 How to Accumulate One Times Your Pre-Retirement Income by Age 35

TABLE 11-6 How to Accumulate Three Times Your Pre-Retirement Income by Age 45

TABLE 11-7 How to Accumulate Seven Times Your Pre-Retirement Income by Age 55

TABLE 11-8 How to Accumulate 10 Times Your Pre-Retirement Income by Age 60

TABLE 11-9 Account Breakdown by Source

Chapter 12

TABLE 12-1 Inflation Adjustment Table

Chapter 13

TABLE 13-1 Annual Returns Comparison

TABLE 13-2 Net Annual Return Comparison (In Percent)

TABLE 13-3 Amount Accumulated With $10,000 Annual Investment (In Dollars)

Chapter 14

TABLE 14-1 The Advantage of Diversifying Your Investments

TABLE 14-2 Vanguard 2040 Target

TABLE 14-3 Sample Historical Average Investment Returns

Chapter 16

TABLE 16-1 Impact of Loan versus Hardship Withdrawal on Account Balance

Chapter 17

TABLE 17-1 IRS Life Expectancy Table III

TABLE 17-2 How Actual Results Can Differ From Your Plan

TABLE 17-3 Planned Withdrawal Strategy

TABLE 17-4 Actual Results for a Target Date Fund

Chapter 18

TABLE 18-1 Requirements for Different Types of 401(k) Plans

Chapter 20

TABLE 20-1 401(k) & IRA Options

TABLE 20-2 Sample SIMPLE Plan

TABLE 20-3 How Employee 401(k) Contributions Affect Owner Contributions

TABLE 20-4 Qualified Automatic Contribution Arrangement 401(k) Contributions

List of Illustrations

Chapter 4

FIGURE 4-1: Positive impact of tax-deferred compounding.

Chapter 5

FIGURE 5-1: Sample 401(k) investment election form.

Chapter 11

FIGURE 11-1: A quick look at the importance of compounding.

Chapter 12

FIGURE 12-1: Sample 401(k) salary deferral form.

FIGURE 12-2: Payoffs of saving early in a 401(k).

Chapter 13

FIGURE 13-1: Pie chart with 55 percent large cap, 20 percent bonds, 10 percent ...

FIGURE 13-2: Pie chart showing 65 percent large cap, 15 percent small cap, and ...

FIGURE 13-3: Pie chart with 50 percent large cap, 5 percent small cap, 10 perce...

Chapter 14

FIGURE 14-1: How returns affect investment growth.

Guide

Cover

Title Page

Copyright

Table of Contents

Begin Reading

Index

About the Author

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Introduction

Bumper stickers I’d love to see: “I’d Rather Be Managing My 401(k)” and “Honk if you love your IRA.” Made you snicker? I agree. Most of us have better things to do with our time than planning for retirement. You probably wouldn’t rather be managing your retirement accounts — you’d rather take in a movie, watch a ball game, or pursue your favorite hobby. But it’s hard to enjoy yourself if you’re plagued by a nagging worry that you could end up destitute in retirement. Spending some time thinking about and planning for your retirement can pay you big dividends down the road.

The concept of retirement has changed dramatically over the last decade or so. Social Security seems less than secure, and it was never meant to cover all your retirement needs, anyway. Most people can’t count on receiving a traditional fixed pension from their employer. The burden of retirement planning falls squarely on your shoulders at a time when you’re living longer and need more money to finance retirement.

I have good news for you. Although you do have to take responsibility for your own retirement saving, you don’t have to let retirement planning take over your life. Investing a bit of time now in ways I explain in this book should enable you to eventually sit back and relax.

There are lots of places where you can find basic information about all the different types of 401(k) and IRA plans, but finding insight into which one may be best for your business is challenging. I include that in this book. I also include ways I have found to utilize these plans to provide benefits comparable to a 401(k) without all the fees and complications of a 401(k).

About This Book

Don’t let the title fool you. 401(k)s and IRAs For Dummies is a useful book that explains the basic rules — and even some obscure ones about various retirement account options. I include information that’s completely up to date, including new rules that went into effect in 2020 with the enactment of the Secure Act, which adds some benefits to 401(k) plan participants. The CARES act was passed in 2020 in response to the COVID-19 crisis.

This book explains essential 401(k) and IRA rules in easy-to-understand language so that you can manage your retirement accounts in a way that leaves you better off in the long run.

This book also explains how to manage risk in your investments and minimize the chances of big losses.

I give examples to show why you should start saving for retirement as soon as you can, because the longer your money stays in your 401(k) and IRA, the bigger your potential nest egg. In fact, if you take only one message away from this book, I hope that it’s “Save as much as you can as early as you can, and invest it sensibly.”

I explain basic principles of long-term investing to help you decide which investment options are right for you. I also give you guidelines to figure out how much you need to save for retirement, and then, after you retire, how to manage withdrawals from your accounts so that your money can last. These are important concepts for 401(k) and IRA investors, but they’re equally important for everyone else.

I have to say this loud and clear: Nothing in this book should be taken as tax advice or investment advice for your specific situation. Everyone is unique, and all I can do is explain some of the more important rules and give you guidance to help you make your own decisions.

Also, because the rules are so complicated, I explain the general rules but leave some of the more technical exceptions to your own expert advisors. I know that most people want someone to tell them exactly what to do, but our lawyers won’t let me do that. You need to consult an investment advisor or tax advisor for advice on your specific situation. But rest assured, reading this book will help you understand the advice that you receive and may save you money by enabling you to have fewer and shorter meetings with your advisors!

I explain things in a way that’s easy to understand; I go into as much detail as necessary for a basic understanding, but no more, and I refer you to additional resources. And heck, I created the first 401(k) plan. How much more authoritative can you get?

To make the content more accessible, it’s divided into six parts:

Part 1

, “The ABCs of 401(k)s and IRAs”

Part 2

, “401(k) Basics”

Part 3

, “Here Come the IRAs”

Part 4

, “Saving and Investing”

Part 5

, “Money In, Money Out”

Part 6

, “Helping Small Employers”

Part 7

, “The Part of Tens”

I think the titles are pretty self-explanatory, but if you’re wondering what a Part contains, check out the Part Page at the beginning of that Part for a quick glimpse of the contents.

Foolish Assumptions

This book is for readers who are either thinking about participating in a 401(k), IRA, or other retirement plan, or who already are participating in a retirement plan but have doubts about what they’re doing. I assume that you have an idea that it’s important to save for retirement, but you’re not sure whether you’re doing it right or how to get started.

You may also be self-employed or a small business owner looking for options for your own retirement plan and to start a plan for your employees.

I try to make things as simple as possible, but I can’t avoid throwing in some math. I assume that you understand some basic economic principles, such as inflation and earning a return on an investment.

For more information about the general investing concepts I cover, I recommend the latest editions of Investing For Dummies and Mutual Funds For Dummies, both by Eric Tyson (Wiley Publishing, Inc.), as well as other resources listed throughout the book.

Icons Used in This Book

Throughout this book, you’ll find helpful icons that highlight particularly useful information. Here’s a quick rundown on what they all mean.

Pay attention to this because it may save you time, money, or aggravation.

Importantissimo. Commit this information to memory.

Ignoring this information may result in painful financial consequences.

You don’t have to know this detailed information, but it wouldn’t hurt. Skip it if you’re in a hurry or not interested. (There aren’t many of these.)

Beyond the Book

In addition to the abundance of information and guidance related to retirement plans in this book, you get access to even more help and information online at Dummies.com. Check out this book’s online Cheat Sheet for fun and helpful additional information. Just go to www.dummies.com and search for “401(k)s & IRAs For Dummies Cheat Sheet.”

Where to Go from Here

The beauty of 401(k)s & IRAs For Dummies is that I’ve organized it so that you can start reading anywhere without risking total confusion. Here are a few suggested starting points, depending on why you picked up the book.

If you’re completely new to the subject, start at the top with

Chapter 1

to get an overview of retirement saving and plans.

If you’re changing jobs and want to know what to do with the money in your employer’s 401(k) plan, head to

Chapter 7

.

If you need to take money out of your 401(k) for an emergency, to put a down payment on a home, or to pay for college expenses, you can find information to help in

Chapter 14

.

If you’re just starting to realize the need and benefits of saving for retirement, go to

Chapter 11

.

If you need knowledge about investments and investing,

Chapters 13

and

14

are the place to go.

If you’re entirely happy with your retirement fund and the investments in it, give a copy of this book to someone who isn’t!

Something else you’ll find in this book that you probably won’t find elsewhere is the section on retirement plans from an employer’s point of view, with tips for small-business owners on choosing a plan. This isn’t easy because there are so many options.

Part 1

The ABCs of 401(k)s and IRAs

IN THIS PART …

Explore the reasons for tax-advantaged retirement plans and compare and contrast the two basic types — 401(k)s and IRAs.

See how and how much you can benefit from tax considerations when you invest in your future through an IRA or 401(k).

Continue planning for the future by naming beneficiaries to your retirement plans and figuring out how best to pass along your money to benefit both you and them.

Chapter 1

Explaining IRAs and 401(k)s

IN THIS CHAPTER

Finding out about 401(k)s and IRAs

Recognizing the pros and cons of each

Seeing the benefits of saving for retirement

My primary goal is to help people concerned about having enough money to successfully retire. Even young people, for whom retirement would normally be low on the priority list, have jumped on the retirement savings bandwagon. They’re the smart ones, because in some respects, how long you save is more important than how much you save.

Looking forward to not having to work is a worthy goal, but remember the paychecks cease when you stop working. Having enough income to sustain yourself during the next 20 to 30 years isn’t easy. Your plans may be disrupted before you reach your planned retirement age. The current COVID-19 pandemic is an example.

Exploring the Basics of Retirement Savings Plans

A retirement plan lets you put some of your income away now to use later, presumably when you’re retired and not earning a paycheck. This process may not appeal to everyone; human nature being what it is, many people would rather spend their money now and worry about later when later comes. That’s why the federal government approved tax breaks to enjoy now — or in April, anyway. Uncle Sam knows that your individual savings are going to be an essential part of your retirement and wants to give you an incentive to participate.

Currently, you have several options for saving for your retirement:

Joining a 401(k) plan, which is an employer-sponsored plan that takes an amount you determine out of your paycheck or automatically enrolls you to contribute and deposits your contributions into your 401(k) account

Starting an IRA, an individual retirement account, on your own and determining your contribution amount and schedule on your own

Joining an IRA-based employer-sponsored retirement plan that takes an amount you determine out of your paycheck and deposits your contributions into an IRA

Your employer automatically contributes a percentage of your pay to a retirement plan

If you’re a solo entrepreneur, setting up a 401(k) or IRA-based plan that may include either employee contributions, employer contributions, or both

I guess you can open a savings account and put money into that, or stick money under your mattress, but neither of these methods will beat 30 to 40 years of inflation, and the mattress method is open to many hazards — fire, flood, boll weevils, and so on. You also won’t get any tax breaks (unless you’re hiding money that hasn’t been taxed, in which case you’ll probably have legal problems to worry about).

The next sections explain both 401(k) and IRA plans.

Getting down to 401(k) basics

When you sign up for a 401(k) plan, you agree to let your employer deposit some of your paycheck into the plan as a pre-tax contribution or as a Roth after-tax contribution or a combination of the two. You put money into your 401(k) plan through a payroll deduction.

Your employer is also permitted to sign you up without your approval, but you have the right to override the percentage you’re automatically enrolled to contribute, including totally opting out. Your employer is required to give you advance notice before automatically enrolling you.

The beauty of a 401(k) is that it makes saving easy and automatic, and you probably won’t even miss the money you put into your retirement account.

I cover the four types of 401(k)s in this book:

A regular 401(k) is sponsored by your employer. Your 401(k) is funded by contributions deducted from your paycheck and deposited into your account. Check out the chapters in

Part 2

for information about regular 401(k)s.

Several types of 401(k) serve the self-employed and other small business owners. I go into detail about the following plans in

Chapter 19

:

Safe harbor 401(k)

Solo 401(k)

Qualified automatic contribution arrangement (QACA) 401(k)

Your employer may set up its own 401(k) or adopt one using a pooled plan provider (PPP) to set up a pooled employer plan (PEP) or become part of a multiple-employer plan (MEP). I cover the different rules for these plans in Chapter 19.

Your employer may throw in some extra money known as a matching contribution. You don’t pay federal income tax on any 401(k) money until you withdraw it.

401(k) plans are like snowflakes — each one is unique. If you’re looking for a standard 401(k) plan, be aware that there’s no such animal. Each company creates its own plan, and some are better than others. Part 2 goes into detail about all the aspects of 401(k)s.

Federal laws govern many aspects of 401(k) plans, but employers are allowed to be more restrictive with their plan rules. For example, the contributions your employer allows may be less than what Uncle Sam permits.

The 401(k) gets its memorable name from the section of Internal Revenue Code (IRC) that governs it. Section 401 of the IRC applies to pension, profit sharing, and stock bonus plans.

A 401(k) plan must satisfy the IRC in both form and operation to be a qualified plan. The rules and regulations governing these plans are massive and complex. Fortunately, your employer deals with making sure the plan you’re offered meets IRC standards. You just have to worry about upholding your end of the arrangement, which this book helps you do.

To meet IRC standards, an employer must adopt a lengthy plan document (150 to 175 pages) and have it approved by the Internal Revenue Service (IRS). The document specifies

Who’s eligible to join the plan

When they’re eligible

How much eligible employees may contribute

The type and amount of any employer contributions

When the employer contribution belongs to the participant

Each plan’s operation must satisfy all the applicable rules and regulations. This includes legislative requirements enacted by Congress and regulations issued by the governmental agencies that have jurisdiction, which include the Treasury Department, the Department of Labor (DoL), and the Securities and Exchange Commission (SEC). The IRS and DoL conduct audits to determine whether an employer is in full compliance.

Introducing IRAs

An IRA, or individual retirement account, is a tax-advantaged way to save for retirement. This is how the government helps workers save for retirement whenever their employers don’t offer a retirement plan.

This book includes information about all the different types of IRAs:

Traditional IRA

Roth IRA

Spousal IRA

Rollover/Conduit IRA

Inherited IRA

Head to Part 3 for details about all these IRAs.

The eligibility rules for a pre-tax traditional IRA depend on whether you or your spouse are covered by an employer-sponsored retirement plan. Otherwise, anyone with earned income can open a traditional IRA. (I cover tax issues and tax terms in Chapter 2.)

With a traditional IRA, you can make contributions on your own anytime up to the date you file your tax return and claim a deduction for your contributions. You don’t get a tax deduction when you contribute to a Roth IRA.

Both a traditional IRA and Roth IRA are invested at a financial institution you select. Your money grows without being taxed with both types of IRA. All withdrawals from a traditional IRA are taxable, and a 10 percent penalty tax is imposed if you withdraw the money prior to age 59½ for any reason other than those that exclude you from the penalty tax. Withdrawals from a Roth IRA aren’t taxable if you follow the rules.

A LITTLE RETIREMENT HISTORY

Did you know that IRAs were permitted long before 401(k)s? What you know as a traditional pre-tax IRA was included in the Employee Retirement Income Security Act (ERISA) passed by Congress on September 2, 1974. That IRAs were included in ERISA is especially surprising because ERISA’s primary purpose was to strengthen the defined-benefit pension system.

Originally, you could own an IRA only if you weren’t covered by an employer-sponsored retirement plan. If you were covered by an employer-sponsored plan, no matter how many or how few benefits the plan provided, you were not eligible to contribute to an IRA.

For example, you can lose all the benefits you earned under an employer-provided pension plan if you left before completing 20 years of service. Or you may have been a participant in an employer-funded profit-sharing plan by an employer that did not make any contributions to the plan or perhaps only small contributions. The 1981 Economic Recovery Tax Act removed the inequity of such situations resulting in the expansion of IRAs to most individuals who have earned income including those covered by employer-sponsored plans.

The Taxpayer Relief Act of 1997 added an additional option — Roth after-tax IRAs. Another step was to expand the Roth option by adding it to 401(k)s during 2006, giving 401(k) participants the option of making pre-tax contributions, Roth after-tax contributions, or some of each.

The traditional IRA and Roth IRA have income thresholds that make higher income earners ineligible to contribute. Participants in 401(k)s are eligible to make Roth contributions regardless of how high their incomes are.

You may be surprised to hear that your author, known as the father of 401(k), thinks there are better alternatives to a 401(k) for solo entrepreneurs, small family businesses, and many other small employers. These IRA-based plans include the following:

Payroll-deduction IRA

SEP IRA

SIMPLE IRA

Chapter 18 includes detailed information about these plans, including why they may be better than a 401(k).

Comparing and Contrasting IRAs and 401(k)s

IRAs and 401(k)s are both retirement savings plans, but after that the resemblance gets dim. Both plans offer

Pre-tax contribution options

A Savers Tax credit for employees who contribute subject to income limits (

Chapter 2

lists the credits and restrictions.)

The ability to grow your money tax-free until you withdraw it

Contrasts between 401(k)s and IRAs are numerous and include the following:

An IRA generally offers more investment choices than a 401(k). Depending on how much choice you like to have, this can be good or bad.

Your employer picks the investments offered in a 401(k), so your options with a 401(k) are limited unless your plan includes a brokerage option compared with the range of investment vehicles you can find for an individual IRA. A 401(k) is thus a disadvantage if you prefer total investment flexibility. On the positive side, your employer is supposed to select investments that are in the sole best interest of participants. Some employers strive to do this, but many don’t. (Many employers have in fact been sued for failing to do so.)

If you have money in a 401(k) plan, you can be forced to withdraw the money when you reach the plan’s normal retirement age, usually 65, unless you’re still working for that employer. With a traditional IRA, you’re required to start taking minimum distributions only after you turn 72. A Roth IRA never requires you to take withdrawals (unless you inherited it).

Money held in a 401(k) may be more secure from your creditors than money in an IRA. IRA protection depends on state law, while 401(k)s are protected by federal law.

401(k) and employer-sponsored IRA plans may include an employer contribution. Whatever amount your employer contributes is a bonus you don’t get with a personal IRA.

Federal laws govern many aspects of 401(k) plans, but employers are allowed to be more restrictive with their plan rules. For example, the contributions your employer allows may be less than what Uncle Sam permits.

STARTING THE FIRST 401(K) PLAN

Paragraph (k) was added to Section 401 via the Tax Revenue Act of 1978. It was only a page and a half long, and it certainly was not expected to be a big deal. It was added by Congress to resolve a battle between Congress and the Treasury over cash-deferred profit-sharing plans. The effective date of this new IRC paragraph was January 1, 1980. This date passed without a rush of employers implementing these plans. I was redesigning the retirement program of a Philadelphia area bank during the fall of 1980. I was drawn to this section of the code as I was considering what the bank was trying to accomplish. It was during this process that I came up with the idea of using this section of the IRC to form a new type of employee retirement savings plan. One with an employer matching contribution and employee pre-tax contributions. Section 401(k) did not include a provision for either type of contribution, but it also did not prohibit them.

The bank’s attorney did not want them to be the pioneers adopting the first 401(k) savings plan. I was part of The Johnson Companies at the time. We implemented the first 401(k) savings plan for our employees effective January 1, 1981, a year after Section 401(k)’s effective date.

This started the launch of employee pre-tax 401(k) plans. Millions of workers have already retired and are enjoying their 401(k) benefits, and millions of active workers are contributing to their plans; however, more than half the private workforce works for employers that do not offer a 401(k) or any other retirement plan.

Accentuating the Positive

Saving for your own retirement may seem like an unnecessary irritation, but it’s very rewarding when you reach the age when you need it. Facing retirement with your only income coming from Social Security is a sure way to tarnish the gold of your golden years.

If you’re fortunate enough to work for an employer who matches a portion of your contribution to your 401(k), you have even more reasons to be a very happy saver.

Saving up

From what people have told me over the years, the biggest benefit of participating in a 401(k) plan is that it turns spenders into savers. Most people want to save for the future, but having money left at the end of the month is tough. Saving becomes your priority with a 401(k). You decide how much of your gross pay to put into the plan and live your daily life on what’s left.

These days, it’s easier than ever to transfer a certain amount every week, month, or paycheck to a retirement account, especially if you’re able to participate in a 401(k). Chapters 11 and 12 have pointers for finding ways to save.

You may face a strong temptation to invade your emergency savings when the first significant emergency hits or you see something you really want to buy. Pulling money from a savings account is easy, but getting money out of a 401(k) isn’t easy at all. So, if you want long-term savings immune from impulse buys, go with a 401(k).

If you’re one of the lucky ones, you’re eligible to contribute to both a 401(k) and an IRA. You are probably also eligible to make Roth contributions either inside or outside the 401(k).

Getting employer contributions

Being able to contribute to a plan that has employer contributions is a big benefit of a 401(k) and employer-based IRA plans. For example, if your employer contributes $0.25 for each $1.00 you contribute limited to the first 6 percent of pay that you contribute, you should strive to contribute 6 percent of your pay, so you get the full employer contribution. Of course, if your employer contributes $1 for each $1 you contribute to the 401(k), that’s the best-case scenario regardless of other factors.

Payroll deduction is magical, so take advantage of putting money into a 401(k), a payroll deduction IRA, or a SIMPLE IRA if you have the opportunity. A payroll deduction IRA may include employer matching contributions to encourage employees to contribute. A SIMPLE IRA must include employer contributions. A personal IRA isn’t an effective alternative unless you’re highly disciplined about managing your money.

Chapter 2

Taxing Issues

IN THIS CHAPTER

Understanding why you get tax breaks

Getting a handle on tax terms

Taking credit when you can

Scoping Social Security issues

Paying taxes before and after you retire

Being prepared for changes in the tax code

It’s up to you — no one else — to plan for a successful retirement. Government policy makers want you to have the resources to retire successfully so that you don’t become a burden to society. With that goal, the government gives you and your employer tax incentives to encourage you to save and your employer to offer retirement plans to make saving easy.

This chapter talks about the whys and hows of taxes as they relate to retirement accounts.

Realizing the Reasons for Tax Breaks

I hope it’s not news to you that Social Security was never intended to provide an adequate level of retirement income. The additional amount you need to retire comfortably must come from other sources. Lawmakers encourage setting aside money for retirement by providing tax breaks and incentives.

What the government gains

Society is stronger if older people are financially secure. Having sufficient resources to provide for themselves eliminates the need for federal and state governments to sustain senior citizens via Medicaid, food stamps, subsidized housing, and other programs.

If people are forced to continue working into their seventies and eighties, that makes it more difficult for teenagers and other younger workers to find employment because both groups are likely to compete for jobs in the service and retail industries.

Having money to spend beyond the bare necessities — going out to eat, buying a new car (even if it’s just new to you), taking vacations, and engaging in other leisure activities — boosts the economy, which in turn provides employment to other workers.

Retirement saving is good for seniors and good for the country.

What you gain

By participating in a retirement saving plan, you do yourself several favors:

You put away money so that you can enjoy your retirement without financial worries.

If you can contribute pre-tax wages, you put off paying taxes until you spend the money. You may even work for an employer that adds money to your account. I talk about 401(k) plans in

Part 2

.

You can deduct qualified traditional IRA contributions when you file your taxes.

Saving so that you have money to live on in your later years is its own reward. Being able to kick back and enjoy the fruits of many years of labor is part of why you work in the first place.

Benefiting from tax advantages while you save is the icing on the retirement cake. The next sections touch on these.

Benefiting from an employer-sponsored plan

Some folks can take advantage of employer-sponsored retirement benefit plans. Most public employers still offer traditional pension plans that provide a stream of monthly lifetime pension income.

If you’re self-employed, you can start your own retirement plan — the chapters in Part 5 offer information on small business plans.

You can put 25 percent or more of your earned income into an IRA-based retirement plan. If set up properly, you can save federal and state income tax, local wage tax, as well as Social Security tax. The combined tax savings if your marginal federal income tax rate is 22 percent will be 40 to 50 percent of the amount you save. A $10,000 contribution can produce $4,000 to $5,000 of tax savings.

You’re one of the fortunate ones if you’re covered by an employer-funded non-401(k) plan, also known as a pension. There are two types of employer-funded pension plans:

Traditional defined benefit plan:

This type of plan pays a lifetime monthly income after retirement. The plan isn’t very valuable unless you spend a lot of years working for the same employer. The value of the benefits you earn are low during your twenties and early thirties. The value of the benefit you earn during your twenties is usually less than $1,000 per year if you earn $50,000 annually. The value increases the longer you stay and the closer you get to retirement.

Cash balance plan:

In this type of plan, the employer contributes a specific percentage of pay for younger employees — typically 3 percent, so $1,500 per year if you earn $50,000 annually. You may have to stay with the employer for three years to get this benefit.

Deducting IRA contributions

If you work for an employer that doesn’t offer any plan, you’re probably eligible to contribute to an IRA. You can contribute $6,000 annually if you are under age 50 plus an additional $1,000 if you are age 50 and over. You can deduct the amount you contribute on your Form 1040 when you file your tax return. These are the 2021 limits.

You may not be eligible to contribute to a traditional IRA if your spouse is covered by an employer-based retirement plan. See “Paying attention if your spouse has a plan” later in the chapter.

Talking Tax Terms

Being an effective and efficient manager of your own money means being familiar with taxes and tax terms. The next sections explain common tax terms it pays to be familiar with, particularly when dealing with an IRA.

Earning your income

Earned income includes the amount you receive from working for someone. Wages, commissions, tips, bonuses, and taxable fringe benefits all count as earned income, as does income from running a business or a farm.

Earned income may also include untaxed military pay, taxed alimony, and disability benefits. Untaxed alimony, child support, Social Security benefits, unemployment, and wages earned by penal institutional inmates are excluded. Your contributions to an IRA can’t exceed your earned income except for contributions to a spousal IRA that come from the employed spouse’s earned income.

Combining your income

Your combined income is what determines how much of your Social Security benefit is taxable.

Your combined income is the total of

Your adjusted gross income

Your nontaxable interest

Half your Social Security benefits

Adjusting your income with AGI

Whether it rings an immediate bell or not, you’re familiar with figuring your adjusted gross income (AGI) at tax time. The IRA defines AGI as “gross income minus adjustments to income.” Your AGI is equal to or less than the total amount of income you had for the tax year depending on the adjustments you’re allowed. Income sources that contribute to your AGI include

Wages on a W-2 or 1099 form

Self-employed income on a Schedule C

Interest and dividends

Alimony from an ex-spouse (for agreements prior to 2019)

Capital gains

Rental income

Retirement distributions

Other earnings subject to income tax

By the time you get to the bottom of the first page of your tax form, you have figured your AGI.

You have many opportunities to take tax deductions on your tax return. Some deductions reduce your income to determine your AGI; these are referred to as adjustments to income. Some current permitted adjustments to your AGI include educator expenses, student loan interest, and IRA contributions. But be aware that tax laws change every year.

Your modified adjusted gross income, or MAGI, is your AGI plus specific add backs of untaxed income. For example, you aren’t taxed on foreign investment income, but your MAGI includes that income.

In a nutshell, your AGI reflects your income; your MAGI is a more complete picture of your financial resources. It’s confusing and one of the many reasons I don’t prepare my own tax return.

Figuring your marginal tax rate

The United States has a graduated tax structure rather than one flat rate in which all taxable income is subject to the same rate. Your income is subject to different tax rates. Your tax rate increases as your taxable income increases.

The more your taxable income, the higher your taxes. You pay a lower rate on the bottom tier of your earnings and pay increasing rates on higher amounts. Table 2-1 shows tax tiers for 2021.

So, if you’re single and have $75,000 of taxable income, you pay 10 percent on $9,950, 12 percent on $9,951 to $40,525, and 22 percent on $40,526 to $75,000. So, 22 percent is your marginal tax rate — the rate you pay on the top portion of your income.

TABLE 2-1 2021 Tax Tiers by Income

Single with Income Up To

Married Filing Jointly with Income Up To

Tax Rate

$9,950

$19,900

10%

$40,525

81,050

12%

$86,375

172,750

22%

$164,925

$329,850

24%

$209,425

$418,850

32%

$523,600

$628,300

35%

over $523,600

over $628,300

37%

Source: Internal Revenue Service

Getting Credit for Contributions

You get an immediate tax break when you make pre-tax contributions to a 401(k) because your taxable pay is reduced by the amount you contribute. You actually authorize your employer to reduce your pay when you join a 401(k). The taxes withheld are reduced; therefore, the reduction in your take home pay is less than the amount you decide to contribute. You don’t get this advantage with Roth contributions to your 401(k) because they’re post-tax contributions.

Deducting IRA contributions

You get a tax reduction when you contribute to a traditional IRA and you file a tax return: Your taxable income is reduced by the amount you contributed. You may also get an additional tax benefit via a tax credit from the government.

If you’re covered by a retirement plan at work, use the information in Table 2-2 to see whether your modified AGI affects the amount of your deduction. These are the 2021 limits.

The amount you can contribute to a Roth IRA is limited by your MAGI as shown in Table 2-3.

If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the “Single” filing status.

TABLE 2-2 2021 IRA Deduction Limits

Your Filing Status

Your Modified AGI

Your Deduction

Single or head of household

$66,000 or less

Up to your contribution limit

More than $66,000 but less than $76,000

Partial deduction

$76,000 or more

No deduction

Married filing jointly or qualifying widow(er)

$105,000 or less

Up to your contribution limit

More than $105,000 but less than $125,000

Partial deduction

$125,000 or more

No deduction

Source: Internal Revenue Service

TABLE 2-3 Roth IRA Deduction Limits

Filing status

2020 MAGI

2021 MAGI

Contribution

Single or head of household

<$124,000

<$125,000

Full contribution

>$124,000 and <$139,000

>$125,000 and <$140,000

Partial contribution

>$139,000

>$140,000

No contribution

Married filing jointly or qualified widow(er)

<$196,000

<$198,000

Full contribution

>$196,000 and <$206,000

>$198,000 to <$208,000

Partial contribution

>$206,000

>$208,000

No contribution

Married filing separately

<$10,000

<$10,000

Partial contribution

>$10,000

>$10,000

No contribution

Source: Internal Revenue Service

Paying attention if your spouse has a plan

The amount of your contributions to an IRA that you can deduct on your tax form may be limited if you or your spouse are covered by a retirement plan.

IRS standards for determining whether you or your spouse are covered by your employer’s retirement plan include the following:

Your employer has a recognized contribution plan, including a 401(k) plan, profit sharing, stock bonus, or money purchase pension plan. A money purchase pension plan is one that an employer contributes to for the employee’s benefit. The employee is barred from contributing but may be able to choose what the funds are invested in.

A defined benefit plan, which is, oddly enough, a pension plan with defined benefits, that you’re eligible to participate in within the tax year counts.

Contributions or forfeitures (a fancy way of saying losses or withdrawals) were registered in your plan during the calendar year or plan year. The contributions may be to a SEP or SIMPLE IRA plan — I talk about those plans in

Chapter 20

.

One way to tell whether you’re covered in an employer-sponsored retirement plan is to check your W-2. If Box 13, the retirement plan box, is checked, you’re covered.

Table 2-4 shows how big a deduction you can take if you or your spouse has an employer-based plan. This table applies even if you or your spouse decides not to contribute to the plan that is available at work.

TABLE 2-4 Deduction Limits if Spouse Has an Employer-Sponsored Plan

Filing Status

2020 MAGI

2021 MAGI

Deduction

Single or head of household

<$65,000

<$66,000

Full deduction

>$65,000 and <$75,000

>$66,000 and <$76,000

Partial deduction

>$75,000

>$76,000

No deduction

Married filing jointly or qualified widow(er)

<$104,000

<$105,000

Full deduction

>$104,000 and <$124,000

>$105,000 and <$125,000

Partial deduction

>$124,000

>$125,000

No deduction

Married filing separately

<$10,000

<$ 10,000

Partial deduction

>$10,000

>$10,000

No deduction

Source: Internal Revenue Service

Earning extra credit according to income

Congress approved an extra tax break to encourage low- and moderate-income earners to contribute to retirement accounts. This tax credit, called the Saver’s Tax Credit, is available to those who contribute to a 401(k), a traditional IRA, and/or a Roth IRA.

The saver’s credit is available if you meet all three conditions:

You’re 18 or older.

You’re not a full-time student.

You’re not claimed as a dependent on someone else’s return.

You were a student if, during any part of five months of the tax year, you

Were enrolled as a full-time student at a school.

Took a full-time, on-farm training course given by a school or a state, county, or local government agency.

A school includes technical, trade, and mechanical schools. It doesn’t include on-the-job training courses, correspondence schools, or schools offering courses only through the internet.

The amount of the credit is 50 percent, 20 percent, or 10 percent of your contributions up to $2,000 — $4,000 if you’re married filing jointly. Eligibility and the amount of the credit is tied to your adjusted gross income. You can’t claim the credit if you make more than $33,000 or $66,000 if you’re married and file jointly. Table 2-5 shows the credit amount in 2021.

TABLE 2-5 2021 Saver’s Tax Credit Rates

Married Filing Jointly

Head of Household

Other Filers

Credit Rate

Up to $39,500

Up to $29,625

Up to $19,750

50%

$39,501–$42,000

$29,626–$32,250

$19,751–$21,500

20%

$42,001–$66,000

$32,251–$49,500

$21,501–$33,000

10%

More than $66,000

More than $49,500

More than $33,000

0%

Source: Internal Revenue Service

The actual calculation of the tax credit has a few more rules that apply, and the amount of your tax credit may be further reduced by any plan withdrawals you (or your spouse) may receive (or have received in the past two years).

You must complete and file Form 8880 to get the credit. Request a copy from your employer or get one from www.irs.gov.

Taxing Income at Retirement

The amount of your taxable income at retirement is an important factor because if you’re like most retirees, you have much less taxable income when you don’t get a paycheck any longer. Social Security benefits are a large portion of most retirees’ income, and they will be for you, too, unless you have substantial assets or significant taxable income from other sources when you retire.

Fun fact: Social Security benefits weren’t taxable until 1984. Today, however, you can pay tax on up to 85 percent of your Social Security benefit — even though you pay federal income taxes on the amount you contribute to Social Security during all the years you work.

This comment used to get people attending my speaking engagements turning their heads, so let me explain: Both your federal income tax and Social Security taxes are computed as part of your gross income. This means you pay federal income tax on your Social Security taxes when you are working and paying them in. You also may have to pay taxes on 85 percent of your Social Security benefits after you retire.

Table 2-6 shows the portion of your Social Security benefit taxable in 2021.

TABLE 2-6 Tax Rates on Social Security Benefits in 2021

Filing Status

0% for Income

50% for Income

85% for Income

Single

Under $25,000

$25,000 to $34,000

Over $34,000

Married Filing Jointly

Under $32,000

$32,000 to $44,000

Over $44,000

Source: Internal Revenue Service

Taxes on your Social Security benefits come into play only if your combined income exceeds $25,000 for a single person and $34,000 for marrieds. If you’re a single taxpayer whose combined income exceeds $34,000 for 2021, 85 percent of your Social Security benefit is taxable. The 85 percent threshold for joint returns is $44,000.

Middle-income workers are the ones who need tax help the most: Lower-income earners receive a much larger percentage of their wages from Social Security, and top earners in large, publicly owned companies receive their big payoffs through employer-funded non-qualified retirement benefits and stock option plans.

An employee currently making $30,000 who retires at the normal Social Security retirement age will receive 45 percent to 50 percent of this amount in Social Security income. Financial pros say you need 70 percent of your pre-tax income as retirement income. So, this retiree needs only 20 percent to 25 percent of non–Social Security income to accomplish this — roughly $225,000 to $250,000 in retirement savings. This is equal to 7.5 to 8.3 times the worker’s $30,000 pre-retirement income.

An employee in the same situation with a $100,000 salary will receive 25 to 30 percent of this amount in Social Security income. This is a much smaller percentage of pay than the $30,000 wage earner even though both employees were paying 7.65 percent of their incomes in FICA tax prior to retirement (assuming they both work for an employer that also pays 7.65 percent). Making matters worse, a self-employed individual earning $100,000 must pay 15.3 percent in FICA taxes.

The $100,000 wage earner has been paying 3.3 times as much in FICA taxes but will receive only 1.7 times as much in benefits. This wage earner also will need sufficient assets to replace 40 to 45 percent of pre-retirement income to hit the 70 percent threshold. That will take $1,000,000 to $1,125,000 of assets — 10 to 11 times the worker’s pre-retirement income.