How Does Each Retirement Plan Affect Your Taxes?

As of 2019, the average monthly Social Security payment is $1,422 and you will most likely need more than that to live comfortably during your retirement. Retirement saving is a top priority for many savers and the earlier you start, the less money it will take. But which retirement account do you open and contribute to? There are many different types of retirement plans and the tax benefits vary greatly. Common factors to consider when choosing a retirement plan are the timing of tax benefit, contribution limit, income limit, and business size. Below are summaries of each common retirement plan.

Traditional 401(k)

• Contributions to traditional 401(k)s are made on a pretax basis, which reduces your taxable income the year contribution is made.
• Contributions are easy to make through payroll deductions.
• 2019 contribution limit: $19,000 a year and additional $6,000 annual “catch-up” contribution if you are 50 or over by end of the year
• The 2019 annual compensation limit is $280,000.
• Total employee/employer contribution limit is the lesser of 100% of an employee’s compensation or $56,000 ($62,000 if eligible for the “catch-up” contribution).

Roth 401(k)

• Contributions are made after tax, but withdrawals/investment earnings are tax free after age 59.5.
• Contributions are easy to make through payroll deductions.
• You can contribute to a traditional and a Roth 401(k) and split the contributions in whatever way you desire as long as the total amount does not exceed the contribution limit of $19,000 in 2019 (additional “catch-up” contribution of $6,000 if you are 50 or over by end of the year).

Traditional IRA Plans

• Traditional IRA is a personal savings plan you are responsible for opening and managing the account, unlike employer sponsored 401k plans.
• Traditional IRA contribution reduces your taxable income the year contribution is made.
• 2019 contribution limit: $6,000 a year or your taxable compensation if your compensation was less than $6,000 (additional “catch-up” contribution of $1,000 if you are 50 or over by end of the year)
• If you’re not covered by a retirement plan at work, there is no income limitation.
• If you are married filing jointly with a spouse who is covered by a plan at work, phase-out starts at $193,000 modified AGI and completely phases out at $203,000 modified AGI.
• If you are covered by a retirement plan at work and
  • Single or head of household, your phase-out starts at $64,000 modified AGI and completely phases out at $74,000 modified AGI
  • Married filing jointly or qualifying widow(er), your phase-out starts at $103,000 modified AGI and completely phases out at $123,000 modified AGI
• Distributions before age 59.5 are taxed as income and subject to a 10% penalty.
• You can’t make contributions after you reach age 70.5.
• There is a required minimum distribution after you reach age 70.5.

Roth IRA plans

• Like Traditional IRA, Roth IRA is a personal savings plan you are responsible for opening and managing the account, unlike employer-sponsored 401k plans
• 2019 contribution limit: $6,000 a year or your taxable compensation if your compensation was less than $6,000 (additional “catch-up” contribution of $1,000 if you are 50 or over by end of the year
• To avoid penalties, you must have the funds in your account for at least 5 years and distributions are made on or after the date you reach age 59.5.
• Unlike Traditional IRA, there is no age limit or required minimum distribution.
• Income limit for Roth IRA
  • Single or head of household: phase-out starts at $122,000 modified AGI and completely phases out at $137,000 modified AGI
  • Married filing jointly or qualifying widow(er): phase-out starts at $193,000 modified AGI and completely phases out at $203,000 modified AGI

SEP (Simplified Employee Pension) IRA plans

• SEP IRA plans provide business owners and self-employed individual a simplified method to make contributions toward their own retirement and their employee’s retirement as well.
• Contributions are tax-deductible including those made to employee accounts.
• SEP IRA annual contribution limits cannot exceed the lesser of:
  • 25% of compensation
  • $56,000 in 2019
• If you have eligible employees, you must contribute on their behalf and those contributions must be an equal percentage of compensation to your own.
• Eligible employees are who are 21 or older, have worked for you for three of the past five years, and earned at least $600 from you in the past year.
• Like Traditional IRA, there is a require minimum distribution beginning at age 70.5.

Simple IRA Plans

• SIMPLE IRAs are usually suited as a start-up retirement savings plan for small employers without a 401k retirement plan.
• Business must have 100 or fewer employees.
• Like traditional IRAs, contributions are made on a pretax basis, which reduces your taxable income the year the contribution is made.
• Employer is require to contribute each year either a:
  • Matching contribution up to 3% of compensation, or
  • 2% nonelective contribution for each eligible employee

At Kauffman|Kim, LLP, we work with affiliated financial advisors to assist you to take the proper steps to reach your goals. The road to retirement is a long one, so don’t make avoidable mistakes.