Tax Information for Retirement Planning

1. Roth IRA versus a traditional IRA. In almost all cases the Roth IRA is a better deal than the traditional IRA. Contributions to Roth IRAs are not deductible on your tax return, but there will be no taxes on the money you take out of your account after age 59 1/2. A Roth IRA is advantageous if your tax bracket will be the same or higher when you retire than what it currently is or if you don't want to take mandatory distributions from your account when you turn 70 1/2. With a Roth IRA you can keep your money in a nest egg for future use past age 70 1/2 or pass it on to your beneficiaries as an income tax-free inheritance.
   
   A contribution to a traditional IRA is fully deductible on your tax return if your employer does not have a retirement plan that you can participate in. If your employer does have a retirement plan you can participate in, then if your adjusted gross income (AGI) is below $50,000 (single) or $70,000 (married filing jointly) your IRA contributions are fully deductible. A traditional IRA may be a good choice if your contribution is deductible and you believe your tax bracket will be lower than it currently is after you retire. However, the younger you are the more advantageous the Roth IRA is.
   
   
2. The retirement saver's credit gives a credit for IRA contributions, Roth contributions, or 401(k) contributions. The retirement saver's credit is only available if your income isn't above the threshholds listed on Form 8880.
   
   
3. If you have a traditional IRA or SIMPLE IRA, you are required to receive a minimum distribution when you reach age 70 1/2. If your distribution is less than the minimum required distribution, a 50% excise tax may be imposed on the shortfall. Minimum distributions do not apply to Roth IRAs.
   
   
4. You can usually make a $5,000 Roth or traditional IRA contribution ($6,000 if older than age 50) for your stay-at-home spouse even if he or she has no earned income.
   
   
5. Roth and traditional IRA contributions can be made after the tax year ends. You have until April 15th of the next year to make an IRA contribution, so a good way to reduce your tax liability after the fact is to make a deductible traditional IRA contribution before you file your tax return. However, it's probably still better to make a Roth contribution and pay a little extra interest and penalties on your underpaid tax return.
   
   
6. Maximize your 401(k) deductions. The deductions lower your taxable income and all earnings are tax-deferred until distributions are received after your retirement. If your employer offers a matching contribution, you have an immediate tax-deferred return on investment as well as a reduction of your wages on your W-2. Another benefit to consider is that any money in your 401(k) account is protected by law against creditors. So if you are ever hit by a lawsuit or have to file bankruptcy, your 401(k) money is safe. CAUTION: IRAs do not have the same protection against creditors that 401(k) plans have.
   
   
7. 401(k) versus Roth IRA. If your company has a 401(k) plan and offers matching contributions, it probably is better to increase your 401(k) deductions to get the maximum amount of employer matching contributions before investing in a Roth IRA. However, your 401(k) earnings are only tax-deferred, whereas Roth IRA earnings are tax-free. You may want to contribute to your Roth IRA first if your employer doesn't offer a good match, you aren't happy with your company's 401(k) earnings performance, or you have a long ways to retirement and would benefit more from the tax-free earnings of a Roth IRA. An advantage of a 401(k) plan is the ability to take a loan from you 401(k) account (some 401(k) plans do not allow loans). This allows you to maximize your 401(k) contributions instead of holding some money back in a rainy day fund, since you know that if you are hard up for money you can always get a loan from your 401(k) account.
   
   
8. If you participate in a 401(k), SEP, SIMPLE IRA, or Keogh Plan, you can still contribute to a traditional IRA or Roth IRA.
   
   
9. Don't raid your 401(k) or IRA and end up paying the 10% early distribution penalty. If you are strapped for cash, consider a home equity loan or line of credit and deduct the interest expense on your tax return. The next best thing may be to get a regular loan or even use your credit cards if the cash crisis can be solved in a year or two. The last thing you want to do is to take a distribution from your 401(k) or IRA account and pay a 10% penalty as well as federal and state taxes (a large distribution will usually bump a taxpayer up to a higher tax bracket). By leaving your money in your 401(k) or IRA account, you will probably earn more tax-deferred income than the amount of interest you are paying on a loan.
   
   
10. If you are a first-time home buyer, you can have a penalty-free distribution of up to $10,000 from your Roth IRA or traditional IRA to purchase your home. You can also take out $10,000 to help your child or grandchild buy their first home. The money needs to be used for acquiring, constructing, financing, or closing costs. Even though the 10% penalty does not apply, you still need to pay regular taxes on the IRA distribution. You are also limited to using $10,000 in your lifetime.
    
    
11. The best way to rollover your IRA, 401(k), or other type or retirement account is to have the rollover distribution be directly rolled over from one plan to the other by your plan administrator. You can obtain the necessary paperwork from your retirement plan administrator to do the direct rollover. If you do a direct rollover, there won't be any taxes withheld from your distribution and the distribution won't be taxable on your tax return. If you don't do a direct rollover and you receive the distribution, then if you want to do a rollover, you need to put the distribution money into another qualified retirement account within 60 days from the day you receive the distribution. Also, if you have taxes withheld from the distribution, you need to come up with the cash to put the full amount of the distribution into the new retirement account to have the full distribution treated as a rollover. EXAMPLE: The taxpayer has $10,000 in a 401(k) account with his old employer. Instead of doing a direct rollover, the plan administrator withholds $2,000 in federal taxes and sends the taxpayer a check for $8,000. If the taxpayer wants to rollover the full $10,000 to his new employer's 401(k) account, he needs to put $10,000 into the new 401(k) account before 60 days have passed. If he only puts in $8,000, then $8,000 will be considered rolled over and $2,000 will be considered taxable income on his tax return.
    
    
12. Taking an early distribution subject to the 10% penalty from your 401(k) or other retirement plan is almost always a bad idea since you pay a lot of taxes and penalties on that distribution. One alternative to taking an early distribution may be to take a loan from your 401(k) or retirement plan. Not all retirement plans offer this option, but if they do then you can borrow part of your retirement plan money and pay it back over time. You pay interest on the 401(k) loan, but the interest goes into your 401(k) account so you are basically paying interest to yourself. There are a couple of negative things about 401(k) loans. First, if you leave your job before you are finished paying back the loan, you will need to pay back the rest of the loan or the remaining loan will be treated as an early distribution subject to the 10% penalty. Second, even though you are paying interest to yourself on the loan, you have taken money out that is no longer in the stock market, so if the stock market is providing a better return on investment than the interest you are paying, you are losing out. But even with these negatives, a 401(k) loan is absolutely better than taking an early distribution.