03/08/2007

The Roth 401(k)

On January 1st, 2006, the Roth 401(k) became the newest option companies can offer in employer-sponsored retirement savings plans. If you are currently enrolled in your company’s 401(k) plan, you are also allowed to enroll in a Roth 401(k) plan, provided your employer chooses to offer both.
 
The Roth 401(k) has similar features to the Roth IRA, which we discussed last week, but it is subject to many IRS rules that apply to traditional 401(k) plans. For example, in 2006, you can contribute up to $15,000 after-tax to the Roth 401(k) and up to $20,000 if you’re over 50. You may enroll in both 401(k) types (traditional and Roth), but the combined contributions cannot exceed $15,000 - you ultimately choose how to split your salary withdrawals for investment.
 
Also, the Roth 401(k) has no income limits and allows employer-matching contributions, however, the employer’s matching portion will remain pre-tax and must continue to land in your traditional 401(k) account. Both Roth 401(k) and Roth IRAs allow tax-free growth on earnings, provided you withdraw at age 59½, and the account has been open at least five years. Where you can withdraw Roth IRA contributions tax and penalty free at any time, Roth 401(k) contributions on the other hand are subject to traditional 401(k) withdrawal guidelines. You may however rollover the Roth 401(k) to a Roth IRA upon retirement or if your employment is terminated.
 
So how do you decide if the Roth 401(k) is right for you? Consider tax diversification - spreading the risk of possible tax rate fluctuations - between now and your retirement. Measure your current tax bracket against what you estimate it will be when you retire. If you’re new to the work force and have a lower tax bracket, you may benefit more by opening a Roth 401(k) which would cause you to pay taxes on your lower income now and make withdrawals tax-free when you’re in a higher bracket during retirement. Conversely, if you’ve been in the work force long enough to build a substantial traditional 401(k) balance, you might want to open a Roth 401(k) to provide you with additional tax-free income to blend with your taxable income in retirement.
 
Although the Roth 401(k) has some benefits for everyone, consult your tax advisor for the optimal mix of retirement plans for you.

03/22/2007

Need IRA Money Early?

 Most of us know that traditional IRAs operate by investing tax-free dollars that earn interest tax-free also. Withdrawals from your IRA are taxed at your regular income tax rate, provided your withdrawal meets the 59 ½ age restriction of your IRA contract. If you withdraw sooner than 59 ½, your withdrawal amount is subject to a 10% penalty in addition to your income tax bracket at that time.

What if you need to use some of your IRA money before you reach 59 ½? There are some exceptions in the IRS code that allow this, but you must be careful to document your adherence to the exceptions list very carefully. The primary early withdrawal exceptions we often hear about are for: medical expenses, disability, divorce settlement, and education expenses. These exceptions only remove the early withdrawal penalty—not the taxes.

There is another early withdrawal exception that is not as common, but could be very beneficial for early retirees. It is called the ‘substantially equal periodic payments’ (SEPP) exception. Section 72(t) of the IRS code allows individuals to withdraw IRA funds prior to 59 ½ by basically spreading the balance in the IRA over the individual’s life expectancy in equal withdrawal amounts. The IRS provides a formula to use in calculating your life expectancy and an interest rate for implied earnings over the years. Should you use the SEPP method, remember that amounts withdrawn each year are still subject to normal income taxes, but you have avoided the penalty for early withdrawal.

Once you begin the SEPP method, you cannot reverse it without being taxed and penalized on the full amount of prior withdrawals. Also, the other exceptions for early withdrawals are not allowed if the SEPP method is elected.

If your circumstances dictate that you only need to withdraw ½ of your IRA prior to 59 ½, you can split your IRA into two IRA accounts and only invoke the SEPP method on the one you plan to deplete with annual equal payments. The remaining IRA would still be subject to the other common exceptions mentioned above. 

You’ve worked hard and saved your money, so make it work for you! Take advantage of alternatives to meet your financial goals when you qualify for them. Always consult a trusted financial advisor when faced with complex investment and distribution decisions.

Back to President's Articles

03/08/2007

The Roth 401(k)

On January 1st, 2006, the Roth 401(k) became the newest option companies can offer in employer-sponsored retirement savings plans. If you are currently enrolled in your company’s 401(k) plan, you are also allowed to enroll in a Roth 401(k) plan, provided your employer chooses to offer both.
 
The Roth 401(k) has similar features to the Roth IRA, which we discussed last week, but it is subject to many IRS rules that apply to traditional 401(k) plans. For example, in 2006, you can contribute up to $15,000 after-tax to the Roth 401(k) and up to $20,000 if you’re over 50. You may enroll in both 401(k) types (traditional and Roth), but the combined contributions cannot exceed $15,000 - you ultimately choose how to split your salary withdrawals for investment.
 
Also, the Roth 401(k) has no income limits and allows employer-matching contributions, however, the employer’s matching portion will remain pre-tax and must continue to land in your traditional 401(k) account. Both Roth 401(k) and Roth IRAs allow tax-free growth on earnings, provided you withdraw at age 59½, and the account has been open at least five years. Where you can withdraw Roth IRA contributions tax and penalty free at any time, Roth 401(k) contributions on the other hand are subject to traditional 401(k) withdrawal guidelines. You may however rollover the Roth 401(k) to a Roth IRA upon retirement or if your employment is terminated.
 
So how do you decide if the Roth 401(k) is right for you? Consider tax diversification - spreading the risk of possible tax rate fluctuations - between now and your retirement. Measure your current tax bracket against what you estimate it will be when you retire. If you’re new to the work force and have a lower tax bracket, you may benefit more by opening a Roth 401(k) which would cause you to pay taxes on your lower income now and make withdrawals tax-free when you’re in a higher bracket during retirement. Conversely, if you’ve been in the work force long enough to build a substantial traditional 401(k) balance, you might want to open a Roth 401(k) to provide you with additional tax-free income to blend with your taxable income in retirement.
 
Although the Roth 401(k) has some benefits for everyone, consult your tax advisor for the optimal mix of retirement plans for you.

03/22/2007

Need IRA Money Early?

 Most of us know that traditional IRAs operate by investing tax-free dollars that earn interest tax-free also. Withdrawals from your IRA are taxed at your regular income tax rate, provided your withdrawal meets the 59 ½ age restriction of your IRA contract. If you withdraw sooner than 59 ½, your withdrawal amount is subject to a 10% penalty in addition to your income tax bracket at that time.

What if you need to use some of your IRA money before you reach 59 ½? There are some exceptions in the IRS code that allow this, but you must be careful to document your adherence to the exceptions list very carefully. The primary early withdrawal exceptions we often hear about are for: medical expenses, disability, divorce settlement, and education expenses. These exceptions only remove the early withdrawal penalty—not the taxes.

There is another early withdrawal exception that is not as common, but could be very beneficial for early retirees. It is called the ‘substantially equal periodic payments’ (SEPP) exception. Section 72(t) of the IRS code allows individuals to withdraw IRA funds prior to 59 ½ by basically spreading the balance in the IRA over the individual’s life expectancy in equal withdrawal amounts. The IRS provides a formula to use in calculating your life expectancy and an interest rate for implied earnings over the years. Should you use the SEPP method, remember that amounts withdrawn each year are still subject to normal income taxes, but you have avoided the penalty for early withdrawal.

Once you begin the SEPP method, you cannot reverse it without being taxed and penalized on the full amount of prior withdrawals. Also, the other exceptions for early withdrawals are not allowed if the SEPP method is elected.

If your circumstances dictate that you only need to withdraw ½ of your IRA prior to 59 ½, you can split your IRA into two IRA accounts and only invoke the SEPP method on the one you plan to deplete with annual equal payments. The remaining IRA would still be subject to the other common exceptions mentioned above. 

You’ve worked hard and saved your money, so make it work for you! Take advantage of alternatives to meet your financial goals when you qualify for them. Always consult a trusted financial advisor when faced with complex investment and distribution decisions.

Back to President's Articles