Small business owners: increase retirement savings with individual 401(k)
July 25, 2011 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
If you’re self-employed or own a small business, you’ve probably considered establishing a retirement plan. If you’ve done your homework, you likely know about simplified employee pensions (SEPs) and savings incentive match plans for employees (SIMPLE) IRA plans. These plans typically appeal to small business owners because they’re relatively straightforward and inexpensive to administer. What you may not know is that in many cases an individual 401(k) plan may be a better deal for you. An individual 401(k) plan is worth considering if you’re looking to set up your first retirement plan or increase tax-preferred savings.
What is an individual 401(k) plan?
An individual 401(k) plan (also known as a solo 401(k)) can be implemented only by self-employed individuals or small business owners who have no other full-time employees (an exception applies if your full-time employee is your spouse). If you have full-time employees age 21 or older (other than your spouse) or part-time employees who work more than 1,000 hours a year, you will typically have to include them in any plan you set up, so adopting an individual 401(k) plan will not be a viable option.
What makes an individual 401(k) plan attractive?
- Contribution levels can generally be higher than SEP or SIMPLE
- The employee part of your contributions can be designated as Roth or traditional regardless of income level
- Easy to set up at most discount brokerages without a lot of extra costs
With an individual 401(k) plan you can elect to defer up to $16,500 of your compensation to the plan for 2011 as either Roth or traditional contributions ($22,000 if you are age 50 or older by the end of the calendar year). In addition, your business can make a maximum tax-deductible contribution to the plan of up to 25 percent of your compensation (slightly less than that if you are a sole proprietor or unincorporated).
There are other details to be aware of, so consult your tax or financial advisor prior to establishing a plan.
Advice Featured in Dallas Morning News
October 11, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The Dallas Morning News hosts an annual financial planning hotline and web chat to allow readers to get free financial advice from members of the Dallas-Fort Worth Financial Planning Assocation. I’ve participated in this event for each of the last 3 years, and this year’s questions reflected many of the issues that Texans are facing right now.
We received many inquiries on debt and how to dig out of some very tough situations. My advice to an online reader on debt settlement vs. debt consolidation was featured in Pamela Yip’s column about the event .
We also fielded questions on Roth IRA conversions. Many folks are considering converting this year because of the unique opportunity to choose between paying all the taxes with your 2010 return or split them over 2011 and 2012. While the opportunity to convert doesn’t go away after this year, the deadline to split the taxes over 2 years is fast approaching on December 31 this year.
There were also questions about contributing to a 401k when an employer has stopped matching, rolling your 401k to an IRA after leaving an employer and many other topics. If you’re interested in reading Ms. Yip’s column on the event, it’s available at DallasNews.com.
Funding early retirement
October 26, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
Most are familiar with the magic ages of 59 ½ when you can start withdrawing from retirement savings without paying the 10% IRS penalty and 62 when you can start taking social security. But sometimes retirement comes before these ages either voluntarily or involuntarily, and you may need income. In those situations, many are not aware that you still have options to tap your retirement savings without penalties.
The first option is available if you are at least age 55 and you stop working for your employer. If your employment terminates during or after the year you turn 55, you are eligible to start drawing funds from that employer’s 401(k) without penalty. If you have multiple retirement accounts, this exception doesn’t apply to all of them. It only applies to those employer retirement accounts where you “separate from service” after turning 55. If you roll the employer plan funds into an IRA, the exception also no longer applies. For qualified public safety employees who take a distribution from a government defined benefit plan, this exception kicks in at age 50.
Another option is called “substantially equal period payments” or 72(t) distributions. You can start taking funds from your retirement accounts (401(k), IRA, 403(b), etc.) at any age with this option, although it doesn’t apply to any employer retirement plans when you’re still working for that employer. To use this option, you are required to begin taking a “substantially equal” amount each year and continue without variation for at least 5 years or until you reach age 59 ½ (whichever comes later). You have a choice of 3 different calculation methods of your payment. Once you start, you are committed to using the same method for the duration of the payments, with the exception of one adjustment allowed from two of the methods to the third one.
The IRS is quite picky about the precise calculations of 72(t) distributions and imposes steep penalties for any mistakes. An error in one year can cause back-penalties on all previous distributions taken. So you really need to consult a professional to have your distributions calculated. And once you start, you absolutely have to stick with the program.
With either of these options, it’s important to look at the big picture of your overall retirement funding. Starting to withdraw from your savings too early can result in a significantly reduced standard of living later on, or it may be just fine in your situation.
Of course, you will still owe taxes on any distributions taken from tax-deferred accounts, and it’s a good idea to plan for those taxes when considering these strategies.
Paying the Bills: Potential Sources of Retirement Income
August 18, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
Planning your retirement income is like putting together a puzzle with many different pieces. One of the first steps in the process is to identify all potential income sources and estimate how much you can expect each one to provide.
Social Security
According to the Social Security Administration (SSA), more than 9 of 10 people aged 65 or older receive Social Security benefits. However, most retirees also rely on other sources of income.
The SSA sends you an estimate of your benefits each year. The closer you are to full retirement age, the more accurate that estimate will be. For a rough estimate, you can use the calculator on the Social Security website (http://ssa.gov).
Your Social Security retirement benefit is calculated using a formula that takes into account your 35 highest earnings years. How much you receive ultimately depends on a number of factors, including when you start taking benefits. You can begin doing so as early as age 62. However, your benefit may be 20% to 30% less than if you waited until full retirement age (65 to 67, depending on the year you were born).
As you’re planning, remember that the question of how Social Security will meet its long-term obligations to both baby boomers and later generations has become a hot topic of discussion. Concerns about the system’s solvency indicate that there’s likely to be a change in how those benefits are funded, administered, and/or taxed over the next 20 or 30 years. That may introduce additional uncertainty about Social Security’s role as part of your overall long-term retirement income picture, and put additional emphasis on other potential income sources.
Pensions
If you are entitled to receive a traditional pension, you’re lucky; fewer Americans are covered by them every year. Be aware that even if you expect pension payments, many companies are changing their plan provisions. Ask your employer if your pension will increase with inflation, and if so, how that increase is calculated.
Your pension will most likely be offered as either a single or a joint and survivor annuity. A single annuity provides benefits until the worker’s death; a joint and survivor annuity provides reduced benefits that last until the survivor’s death. The law requires married couples to take a joint and survivor annuity unless the spouse signs away those rights. Consider rejecting it only if the surviving spouse will have income that equals at least 75% of the current joint income. Be sure to fully plan your retirement budget before you make this decision.
Work or other income-producing activities
Many retirees plan to work for at least a while in their retirement years at part-time work, a fulfilling second career, or consulting or freelance assignments. Obviously, while you’re continuing to earn, you’ll rely less on your savings, leaving more to accumulate for the future. Work also may provide access to affordable health care.
Be aware that if you’re receiving Social Security benefits before you reach your full retirement age, earned income may affect the amount of your benefit payments until you do reach full retirement age.
If you’re covered by a pension plan, you may be able to retire, then seek work elsewhere. This way, you might be able to receive both your new salary and your pension benefit from your previous employer at the same time. Also, some employers have begun to offer phased retirement programs, which allow you to receive all or part of your pension benefit once you’ve reached retirement age, while you continue to work part-time for the same employer.
Other possible resources include rental property income and royalties from existing assets, such as intellectual property.
Retirement savings/investments
Until now, you may have been saving through retirement accounts such as IRAs, 401(k)s, or other tax-advantaged plans, as well as in taxable accounts. Your challenge now is to convert your savings into ongoing income. There are many ways to do that, including periodic withdrawals, choosing an annuity if available, increasing your allocation to income-generating investments, or using some combination. Make sure you understand the tax consequences before you act.
Some of the factors you’ll need to consider when planning how to tap your retirement savings include:
- How much you can afford to withdraw each year without exhausting your nest egg. You’ll need to take into account not only your projected expenses and other income sources, but also your asset allocation, your life expectancy, and whether you expect to use both principal and income, or income alone.
- The order in which you will tap various accounts. Tax considerations can affect which account you should use first, and which you should defer using.
- How you’ll deal with required minimum distributions (RMDs) from certain tax-advantaged accounts. After age 70½, if you withdraw less than your RMD, you’ll pay a penalty tax equal to 50% of the amount you failed to withdraw.
Some investments, such as certain types of annuities, are designed to provide a guaranteed monthly income (subject to the claims-paying ability of the issuer). Others may pay an amount that varies periodically, depending on how your investments perform. You also can choose to balance your investment choices to provide some of both types of income.
Inheritance
One widely cited study by economists John Havens and Paul Schervish forecasts that by 2052, at least $41 trillion will have been transferred from World War II’s Greatest Generation to their descendants. (Source: Why the $41 Trillion Wealth Transfer Is Still Valid) An inheritance, whether anticipated or in hand, brings special challenges. If a potential inheritance has an impact on your anticipated retirement income, you might be able to help your parents investigate estate planning tools that can minimize the impact of taxes on their estate. Your retirement income also may be affected by whether you hope to leave an inheritance for your loved ones. If you do, you may benefit from specialized financial planning advice that can integrate your income needs with a future bequest.
Equity in your home or business
If you have built up substantial home equity, you may be able to tap it as a source of retirement income. Selling your home, then downsizing or buying in a lower-cost region, and investing that freed-up cash to produce income or to be used as needed is one possibility. Another is a reverse mortgage, which allows you to continue to live in your home while borrowing against its value. That loan and any accumulated interest is eventually repaid by the last surviving borrower when he or she eventually sells the home, permanently vacates the property, or dies. (However, you need to carefully consider the risks and costs before borrowing. A useful publication titled “Reverse Mortgages: Avoiding a Reversal of Fortune” is available online from the Financial Industry Regulatory Authority.)
If you’re hoping to convert an existing business into retirement income, you may benefit from careful financial planning to minimize the tax impact of a sale. Also, if you have partners, you’ll likely need to make sure you have a buy-sell agreement that specifies what will happen to the business when you retire and how you’ll be compensated for your interest.
With an expert to help you identify and analyze all your potential sources of retirement income, you may discover you have more options than you realize.
August 2009 newsletter
August 5, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The August newsletter is now available. It includes information on 2010 social security and medicare numbers for planning purposes, whether creditors can go after your 401(k) and more. To view it, click here.
401(k) options when you change jobs
July 6, 2009 by Jean Keener, CFP, CRPC, CFDS · 1 Comment
If you’ve lost your job, or are changing jobs, you may be wondering what to do with your 401(k) plan account. It’s important to understand your options.
What will I be entitled to?
If you leave your job (voluntarily or involuntarily), you’ll be entitled to a distribution of your vested balance. Your vested balance always includes your own contributions (pretax, after-tax, and Roth), and any investment earnings on those amounts. It also includes employer contributions and earnings that have satisfied your plan’s vesting schedule. In general, you must be 100% vested in employer contributions after 3 years of service (”cliff vesting”), or you must gradually vest 20% per year until you’re fully vested after 6 years (”graded vesting”). Some plans have 100% immediate vesting. You’ll also be 100% vested if you’ve reached your plan’s normal retirement age.
Special vesting rules apply to certain plans, so make sure you understand how your particular plan’s vesting schedule works. This is important, because you’ll forfeit any employer contributions that haven’t vested by the time you leave your job. If you’re on the cusp of vesting, it may make sense to wait a bit before leaving, if you have that option.
Don’t spend it, roll it!
While this pool of dollars may look attractive, don’t spend it unless you absolutely need to. If you take a full distribution you’ll be taxed, at ordinary income tax rates, on the entire value of your account except for any after-tax or Roth 401(k) contributions you’ve made. And, if you’re not yet age 55, an additional 10% penalty may also apply to the taxable portion of your payout. (Because of the 5-year holding period requirement, there won’t be any tax-free qualified distributions from Roth 401(k) accounts until 2011 at the earliest. And special rules may apply if you receive a lump-sum distribution and you were born before 1936, or if the lump sum includes employer stock.)
If your vested balance is more than $5,000, you can leave your money in your employer’s plan until you reach normal retirement age. In some cases, however, your best bet will be to roll the funds over to an IRA. It really depends on the investment options in your old employer’s plan, the fees, and how many other prior employer’s plans you still have money in. Consolidating 401(k) balances from multiple former employers can make it much easier to maintain your desired asset allocation, keep costs low, and reduce paperwork for you.
Your employer must allow you to make a direct rollover to an IRA. As the name suggests, in a direct rollover the money passes directly from your 401(k) plan account to your IRA. This is preferable to a “60-day rollover”–where you get the funds and then roll them over to an IRA yourself–because your employer has to withhold 20% of the taxable portion of a 60-day rollover. You can still roll over the entire amount of your distribution, but you’ll need to come up with the 20% that’s been withheld from other funds until you recapture that amount when you file your income tax return.
If you really do need to use some of the money, and you have nontaxable after-tax or Roth contributions in your account, keep in mind that you may be able to roll over the taxable portion of your distribution to an IRA, and take a distribution of just the nontaxable portion of your account. Again, avoid using retirement plan savings if at all possible. It can do permanent damage to your retirement funding, and it’s really hard to catch back up!
What if I have an outstanding plan loan?
In general, if you have an outstanding plan loan, you’ll need to pay it back, or the outstanding balance will be taxed as if it had been distributed to you in cash. If you can’t pay the loan back before you leave, you’ll still have 60 days to roll over the amount that’s been treated as a distribution to your IRA. Of course, you’ll need to come up with the dollars from other sources.
February 2009 Newsletter
February 5, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The February 2009 KFP newsletter is now available. The topics for this month are: What to do when your employer stops matching your 401(k), working during retirement, college costs update, and your credit score. There’s also some information on the Your Money Bus tour stop in D-FW. Enjoy!
Click here to view the February 2009 newsletter.
2009 contribution limits announced
November 2, 2008 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
On October 16, 2008, the IRS issued news release IR-2008-118 announcing cost-of-living adjustments to dollar limitations for pension plans. Items addressed for 2009 include:
Elective deferrals
* The annual elective deferral limit for 401(k) plans, 403(b) plans, 457(b) plans, SAR-SEPs, and the federal government’s Thrift Savings Plan increases from $15,500 to $16,500
* The annual elective deferral limit for SIMPLE plans is increased from $10,500 to $11,500
Employee “catch-up” contributions for individuals age 50 or older
* The annual limit on additional catch-up contributions to 401(k), 403(b), and Section 457(b) plans is increased from $5,000 to $5,500
* The annual limit on additional catch-up contributions to a SIMPLE plan remains unchanged at $2,500
Other key figures
* The dollar limit on annual additions to a defined contribution plan increases from $46,000 to $49,000
* The dollar limit on the annual benefit under a defined benefit plan increases from $185,000 to $195,000
* The annual compensation limit for qualified retirement plan purposes increases from $230,000 to $245,000
* The annual compensation amount used in the definition of a highly compensated employee increases from $105,000 to $110,000
* The annual compensation amount used in the definition of a key employee in a top-heavy plan increases from $150,000 to $160,000
* For purposes of determining a qualifying employee under a simplified employee pension (SEP) plan, the minimum amount of annual compensation is increased from $500 to $550