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Make the Most of Your Retirement Contributions
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.
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
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.
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.
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?
to a traditional IRA may be deductible or nondeductible. Anyone
eligible to contribute to an IRA can contribute on a nondeductible
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
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.
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.
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.
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
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
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.
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.
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
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
SIMPLE IRA Plans
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
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.
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
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.
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.
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.
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.
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.