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Make the Most of Your Retirement Contributions

 Alexandra Armstrong CFP, CCPS and Karen Preysnar  CFP Bookmark and Share

Given today’s longevity, most people will be retired longer than they’ll work. Unfortunately, few companies provide pensions, and we’re unsure how long Social Security will provide retirement income at its current levels. Therefore, it’s up to each of us to make saving for our own retirement a priority. Start contributing to a retirement account as early as you can and as much as you can. If you have adult children struggling to make ends meet, help them if you can by providing money so that they can max out their retirement plans.

This month we’ll review the retirement contribution limits for 2010. Given the challenges of today’s economy, some people have cut back on their retirement savings. But we strongly recommend that you continue saving for retirement, even if you can’t afford to contribute the maximum. Since we think many investments offer a good value at this time, we encourage you to continue contributing as much as you can even if it means cutting back on your discretionary spending.
To determine what “as much as you can” actually means, it’s important to first make sure you have enough cash outside of your retirement accounts. We suggest you keep an emergency cash reserve that would cover about three to six months’ worth of your expenses, if necessary. If you don’t have a reserve and unexpected expenses arise or you lose your job, you may be forced to withdraw money from a retirement plan prematurely, which may result in you having to pay income taxes and possibly penalties.
You also need to think about any expenses that may arise within the next few years. Examples are home repairs or improvements, a new car, a vacation, the down payment on a house and so on. Ideally, you should accumulate sufficient money to pay these expenses ahead of time. But we think contributing the maximum to your retirement plan should be a priority. Perhaps you should rethink that decision to spend money on a new car or a vacation and instead build your retirement assets so that your retirement years really are your golden years, not your nickel-and-dime years.
The contribution limits for most retirement plans stayed the same from 2009 to 2010 because of the low inflation rate last year. But in the future you’ll want to monitor the limits and increase your contributions accordingly to take full advantage of the retirement savings plans available to you.

Traditional IRAs

For 2010, you can contribute $5,000 to a traditional IRA if you earn at least that much and are under age 70 1/2  for the entire year. If you turn 50 years old by the end of 2010, you can also make a $1,000 catch-up contribution for a total contribution of $6,000. If you earn less than this amount, the maximum you can contribute is the amount of your earnings. We suggest you make your IRA contributions early in the year so that the earnings on the money you invest will be sheltered from taxes as long as possible.
You have until April 15, 2010, to make an IRA contribution for 2009. So if you have not yet contributed for 2009, we encourage you to do so. Note that if you’re married and file a joint tax return with your spouse, you’re allowed to make an IRA contribution based on your spouse’s earnings even if you don’t work. For example, if you don’t work but your spouse earns $12,000, you can each contribute $6,000, assuming you’re both at least 50 years old.

Is Your IRA Contribution Deductible?

Contributions to a traditional IRA may be deductible or nondeductible. Anyone eligible to contribute to an IRA can contribute on a nondeductible basis.
If neither you nor your spouse participates in any other qualified retirement plan, you can deduct your traditional IRA contribution regardless of your income level. Otherwise, your deduction depends on your modified adjusted gross income*, your tax-filing status and whether you’re the qualified plan participant or only your spouse is.
If you participate in a qualified plan, to deduct your contribution in full, your modified AGI must be less than $56,000 if you’re single or $89,000 if you’re married and file a joint tax return. Between $56,000 and $66,000 (single) or $89,000 and $109,000 (married filing jointly), your deduction is phased out. Above these levels, you can’t deduct your IRA contributions.
If you’re married and you don’t work but your spouse does and your spouse is covered by a qualified plan, you’re subject to a different income limit than your spouse is.  You’ll be able to deduct your entire IRA contribution if your modified AGI is less than $167,000. A partial deduction is allowed when your modified AGI is between $167,000 and $177,000, and above $177,000 no IRA deduction is allowed.
For example, let’s say that Bill and Beverly will have a combined modified AGI of $150,000 in 2010. Since Bill participates in a 401(k) plan at work and their modified AGI is over $109,000, he won’t be able to deduct his IRA contribution for 2010. Beverly doesn’t work, however, and can deduct her entire IRA contribution, since she’s a nonparticipant spouse and their modified adjusted gross income is less than $167,000.

Roth IRA

The maximum contribution to a Roth IRA is also $5,000 for 2010, $6,000 if you’re 50 or older. Unlike traditional IRAs, you can contribute to a Roth IRA even if you’re over age 70 1/2. You or your spouse must have earned income to contribute to a Roth IRA. Not everyone who works can contribute, however. Roth IRA contributions are phased out if the modified adjusted gross income is $105,000 to $120,000 for a single taxpayer or $167,000 to $177,000 for taxpayers filing jointly.
As long as you’re eligible to contribute to both types of IRAs, you can mix and match your contributions between the two as long as the total of all your IRA contributions doesn’t exceed the $5,000/$6,000 limit. For example, you could contribute $2,500 to a traditional IRA and $2,500 to a Roth IRA in the same year.
Roth IRA contributions are never deductible. One of the major benefits of the Roth is that if you meet certain requirements, the money you withdraw is tax-free. Another benefit is that there are no required minimum distributions at age 70 1/2.
Another way to put money into a Roth IRA is to do a Roth IRA conversion. This option is available to all taxpayers starting in 2010. In prior years, it was allowed only if your modified AGI was less than $100,000. For more information, see our discussion of Roth conversions in the February 2010 issue of BetterInvesting Magazine along with articles this month in Professional Opinion and the cover story.

401(k), 403(b) and 457 Plans

For 2010, you can contribute up to $16,500 to a 401(k), 403(b) or 457 plan. In addition, if you’re age 50 or older, you can make a catch-up contribution of $5,500 for a total contribution of $22,000 in 2010. The federal government’s Thrift Savings Plan follows these rules as well. Some employers have their own lower limitations on how much of your salary you can contribute. If that’s the case, you’re subject to that limit.
If you contribute to a 401(k) or 403(b) plan, your tax-deductible contributions will produce tax savings that will help to reduce your out-of-pocket cost. As you increase the contributions you make through your payroll deductions, the amount of federal and state taxes withheld from your pay goes down. In other words, if you begin contributing $500 per pay period, your net salary will go down by less than $500 because less tax will be withheld.

Roth 401(k)

Some employers offer Roth 401(k) plans. This type of plan combines the benefits of a Roth IRA with those of a regular 401(k). Employers can add the Roth 401(k) option to their existing 401(k) plan, but they aren’t required to do so.
Roth 401(k) contributions are made through payroll deductions, but they’re not tax-deductible. Whether you contribute to a regular 401(k), a Roth 401(k), or both, the overall 401(k) limits apply to your combined contributions. In other words, you can choose to contribute some of your pay to each type of 401(k) plan, but you can’t contribute $16,500 to both plans.
Unlike Roth IRAs, you’re allowed to contribute to a Roth 401(k) regardless of your income level. This is good news for people who want to contribute to a Roth IRA but can’t because their income is too high. Another difference between the Roth IRA and the Roth 401(k) is that the Roth 401(k) is subject to the required minimum distribution rules when you turn age 70 1/2.
Under current law, however, a Roth 401(k) can be rolled over to a Roth IRA in order to avoid having to take distributions.

SEP-IRA and Keogh Plans

If you have a SEP (Simplified Employee Pension) IRA or a Keogh plan, the maximum contribution in 2010 is the lesser of $49,000 or 25 percent of your compensation. If you’re self-employed, however, your actual contribution works out to be about 20 percent. The percentage may vary depending on your tax situation. This computation is tricky, so we recommend that you consult your tax adviser about the amount you can contribute.


For 2010, employees can contribute up to $11,500 to a SIMPLE IRA (Savings Incentive Match Plan for Employees), plus a $2,500 catch-up contribution if they’re at least
50 years old. An employer’s mandatory matching contributions are made in addition to these amounts.

Individual 401(k) Plans

An Individual 401(k) plan can be established by a business owner who has no employees other than a spouse. This is a great opportunity for business owners who would like to contribute large amounts to a retirement plan. Before Individual 401(k)s were available, the only real option for putting away a large percentage of your income was to set up a defined-benefit pension plan. Pension plans are complex and are expensive to set up and maintain, whereas Individual 401(k) accounts are relatively straightforward.
For 2010, the maximum contribution to an Individual 401(k) is the lesser of $49,000 or 25 percent of your compensation, about 20 percent if you’re self-employed. A $5,500 catch-up contribution is also allowed if you are at least 50 years old for a total contribution of $54,500 in 2010.
The contribution rules for this type of plan are unique. For the first $16,500 of compensation — $22,000 if you’re over age 50 — you can contribute 100 percent. If you earn more than that, you can also contribute up to 25 percent of your compensation  — about 20 percent if self-employed — until you reach the overall dollar limit of $49,000, $54,500 if you’re 50 or older. You can contribute a greater amount at lower levels of compensation than you can with a SEP-IRA, SIMPLE IRA or Keogh plan.
For example, if you’re incorporated and you earn $22,000 in 2010, you can contribute the full $22,000 if you’re over 50 years old. If you earn $60,000, you can contribute $37,000, which is $22,000 plus 25 percent of $60,000. This would be about 56 percent of your earnings. By comparison, you would be able to contribute only $15,000 to a SEP-IRA or $20,800 to a SIMPLE IRA.

Contribution Deadlines

Traditional and Roth IRAs must be established by April 15, and contributions must be made by that date as well. Contributions to SEP-IRAs and Keoghs can be made as late as the due date of your tax return, including extensions. A Keogh plan must be established by the end of the calendar year for which you’re contributing, but that requirement doesn’t apply to a SEP-IRA. Therefore, if you have net self-employment income and you file an extension for your 2009 tax return, you have until Oct. 15, 2010, to open and contribute to a SEP-IRA for 2009.
A SIMPLE IRA must be established no later than Oct. 1 for the year. This requirement is waived if you’re a new employer who began operating after Oct. 1. Contributions can be made as late as the employer’s tax-filing deadline, including extensions.
Individual 401(k) plans must be established by the last day of the business’s tax year. For self-employed individuals and corporations that operate on a calendar year, the plan must be established by Dec. 31. If the corporation has a different fiscal year-end, then the fiscal year-end will be the deadline for that business. Contributions must be made by the business’s tax-filing deadline, including extensions.

Many Opportunities

As you can see from this article, there are many different opportunities for retirement savings, particularly for self-employed individuals. Some offer tax deductions while others don’t. To determine the best approach for you, we recommend that you discuss your situation with your tax adviser.

* Modified AGI = Adjusted gross income plus traditional IRA deduction, student loan interest deduction, tuition and fees deduction, foreign earned-income exclusion, foreign housing exclusion or deduction, qualified interest on U.S. Savings Bonds used for higher education and exclusion of employer-paid adoption expenses. (When determining eligibility for Roth IRA contributions, taxable income from a Roth IRA conversion is also subtracted from modified AGI.) 

Alexandra Armstrong is co-author of the fourth edition of On Your Own: A Widow’s Passage to Emotional and Financial Well-Being. She is a Certified Financial Planner practitioner and chairman of Armstrong, Fleming & Moore, Inc., a registered investment advisory firm in Washington, D.C. Securities are offered through Commonwealth Financial Network, member FINRA/SIPC. Investment advisory services are offered through Armstrong, Fleming & Moore, Inc., an SEC-registered investment adviser not affiliated with Commonwealth Financial Network.
Karen Preysnar, Certified Financial Planner practitioner, co-author of this article, is vice president in charge of financial planning at Armstrong, Fleming & Moore, Inc., and a registered representative with Commonwealth Financial Network.
Individuals should contact a financial planner, tax adviser or attorney when considering these issues. Commonwealth Financial Network does not give tax or legal advice. Consult your personal adviser before making any decisions. The authors cannot answer individual inquiries, but they welcome suggestions for article topics.

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