By JOHN HALL
Being an employee of a small business is exciting and has advantages such as independence, growth opportunity and a sense of community. But one area where many small businesses fall flat is employee benefits. Chief among those missing benefits is the option of a retirement savings plan. Just because your employer doesn’t offer a retirement plan, however, doesn’t mean that there are no options available to you. Here are a few to consider:
1) Roth IRA. The Roth IRA is one of the most flexible, useful and attractive retirement savings options out there. Here’s how it works:
You put away money in an account in your name. You can contribute up to $5,500 per year. If you’re 50 or older, you can contribute up to $6,500 per year. These are after-tax contributions, meaning that you have already paid taxes on the money you contribute. You choose to invest the money as conservatively or as aggressively as you’d like. From that point forward, the invested monies grow tax-free. The investment income within the account is also tax-free. When you take out the money after age 59 and a half, you owe no federal income tax or penalty on what you take out. That, in and of itself, is a wonderful thing.
Here are more great attributes of a Roth IRA:
• If you need to extra money before retirement, you can withdraw your original contributions tax-free.
• You can withdraw up to $10,000 to build or buy your first home, tax and penalty free.
• So long as you continue to earn qualifying income, there are no upper-age limits to stop older savers from contributing to a Roth IRA.
• There are no Required Minimum Distributions. You may keep your money in your Roth IRA as long as you’d like.
• Distributions to your beneficiaries when you pass away are free of federal income tax.
Isn’t that great? You can save money, pay no federal taxes on its growth and have the flexibility to spend the money for college and first-time home purchases. For these reasons, I suggest a Roth IRA to most young people who ask me which type of retirement account they should establish. So, you ask, what’s the catch? Uncle Sam recognizes that these accounts are almost too good to be true, so there are income limits on who can contribute to a Roth IRA. In 2015, these limits start at $116,000 for individuals and $183,000 for married couples filing jointly.
2) Traditional IRA. A Traditional IRA works much the same as a 401(k) or 403(b) that many employers offer. The annual contribution limits ($5,500 and $6,500) are the same as for a Roth IRA. Where these two savings vehicles differ is in their tax treatment. Contributions to a traditional IRA are pre-tax. This means that for every dollar you contribute to a Traditional IRA, you can deduct a dollar from your taxable income. As an example, if you’re in the 25% federal tax bracket, and you contribute $5,500 to your Traditional IRA, then you’re saving yourself $1,375 in federal taxes for that contribution year. That sounds great, so what’s the catch? You have to pay income taxes on the money when you take it out of your IRA in retirement—whether the withdrawal is from your original contribution or from the investment earnings and growth that have accumulated over time. Until that time, your earnings have grown tax-deferred. Besides the tax treatment, there are some other key differences between a traditional IRA and a Roth IRA. For instance, with a Traditional IRA:
• Once you turn 70 and a half, the government requires that you take
(and pay taxes on) distributions from your account.
• Once you turn 70 and a half, you can no longer make contributions to your account.
• There is no income limit meaning you can make contributions to a traditional IRA no matter how high your income (there are income limits for tax deductibility however).
3) Taxable Investment or Savings Account. Here, I’m talking about a standard investment account, with no special retirement designation and no differentiated tax treatment. This account can include any type of investment you’d like, from FDIC-insured CDs to individual stocks. Why might you consider this an option for your retirement savings?
• You’ve already contributed the maximum to your IRA and would like to save more money.
• You need more flexibility than either IRA option offers to be able to spend your money before retirement.
• You don’t qualify for a Roth IRA and anticipate your federal tax bracket at the time of retirement to be prohibitively high.
So, which option is right for you? It may be that one of these is all you need to consider. You may want to consider a combination of the different accounts. In the end, using any of these tools to save money towards retirement is better than doing nothing. I’d encourage you to speak with your tax-preparer and investment advisor to map out a strategy that starts building your retirement nest egg today!
Disclaimer: This column is for informational purposes and should not be considered personalized investment advice. Everyone’s circumstance is different, and individuals should seek investment advice based on his or her unique financial situation. All investments are subject to risk, including loss of principal.