Tax-deferred annuities can be a valuable tool, particularly for retirement savings. However, they are not appropriate for everyone.
Five questions to consider
Think about each of the following questions. If you can answer yes to all of them, an annuity may be a good choice for you.
Are you making the maximum allowable pretax contribution to employer-sponsored retirement plans (a 401(k) or 403(b) plan through your employer, or a Keogh plan or SEP-IRA if you are self-employed), or to a deductible traditional IRA? These are tax-advantaged vehicles that should be fully utilized before you contribute to an annuity.
Are you making the maximum allowable contribution to a Roth IRA, Roth 401(k), or Roth 403(b), which provide additional tax benefits not available in a nonqualified annuity?
Will you need more retirement income than your current retirement plan(s) will provide? If you begin making the maximum allowable contributions to both a qualified plan and an IRA in your 30s or early 40s, you may have enough retirement income without an annuity.
Are you sure you won’t need the money until at least age 59½? Withdrawals from an annuity made before this age are usually subject to a 10 percent early withdrawal penalty tax on earnings levied by the IRS.
Will you take distributions from your annuity on an ongoing basis throughout your retirement? You typically have the option of making a lump-sum withdrawal from an annuity, but this is almost always a bad idea. If you do, you’ll have to pay taxes on all of the earnings that have built up over the years. If you take gradual distributions, you pay taxes a little at a time, allowing the rest of the money to continue growing tax deferred. In addition, if the annuity is nonqualified and you elect to receive an annuity payout, you will enjoy an exclusion allowance on each payment, in which a portion of each payment is considered a return of principal and is not taxable.
Article Written By: Forefield Inc.
Neither Forefield Inc. nor Forefield Advisor provides legal, taxation, or investment advice. All content provided by Forefield is protected by copyright. Forefield claims no liability for any modifications to its content and/or information provided by other sources.
For professional investment advice on this topic contact: Allgen Financial Services, Inc.
888.6ALLGEN (888) 625-5436
advisors@allgenfinancial.com www.allgenfinancial.com
Employers can offer 401(k) plan participants the opportunity to make Roth 401(k) contributions. If you’re lucky enough to work for an employer who offers this option, Roth contributions could play an important role in maximizing your retirement income.
What is a Roth 401(k)?
A Roth 401(k) is simply a traditional 401(k) plan that accepts Roth 401(k) contributions. Roth 401(k) contributions are made on an after-tax basis, just like Roth IRA contributions. This means there’s no up-front tax benefit, but if certain conditions are met, your Roth 401(k) contributions and all accumulated investment earnings on those contributions are free from federal income tax when distributed from the plan. (A 403(b) plan can also allow Roth contributions.)
Who can contribute?
Unlike Roth IRAs, where you can’t contribute if you earn more than a certain dollar amount, you can make Roth contributions, regardless of your salary level, as soon as you are eligible to participate in the 401(k) plan. And while a 401(k) plan can require employees to wait up to one year before they become eligible to contribute, many plans allow you to contribute beginning with your first paycheck.
How much can I contribute?
There’s an overall cap on your combined pretax and Roth 401(k) contributions. In 2008, you can contribute up to $15,500 ($20,500 if you’re age 50 or older) to a 401(k) plan. You can split your contribution between Roth and pretax contributions any way you wish. For example, you can make $8,000 of Roth contributions and $7,500 of pretax 401(k) contributions. It’s up to you. But keep in mind that if you also contribute to another employer’s 401(k), 403(b), SIMPLE, or SAR-SEP plan, your total contributions to all of these plans–both pretax and Roth–can’t exceed $15,500 in 2008 ($20,500 if you’re age 50 or older). It’s up to you to make sure you don’t exceed these limits if you contribute to plans of more than one employer.
Can I also contribute to an IRA?
Yes. Your participation in a 401(k) plan has no impact on your ability to contribute to an IRA (Roth or traditional). You can contribute up to $5,000 to an IRA in 2008 ($6,000 if you’re age 50 or older). But, depending on your salary level, your ability to make deductible contributions to a traditional IRA may be limited if you participate in a 401(k) plan.
Are distributions really tax free?
Because your Roth 401(k) contributions are made on an after-tax basis, they’re always free from federal income tax when distributed from the plan. But the investment earnings on your Roth contributions are tax free only if you meet the requirements for a “qualified distribution.”
In general, a distribution from your Roth 401(k) account is qualified only if it satisfies both of the following requirements:
It’s made after the end of a five-year waiting period
The payment is made after you turn 59½, become disabled, or die
The five-year waiting period for qualified distributions starts with the year you make your first Roth contribution to the 401(k) plan. For example, if you make your first Roth contribution to your employer’s 401(k) plan in December 2008, your five-year waiting period begins January 1, 2008, and ends on December 31, 2012. If you participate in more than one Roth 401(k) plan, your five-year waiting period is generally determined separately for each employer’s plan. But if you change employers and roll over your Roth 401(k) account from your prior employer’s plan to your new employer’s Roth 401(k) plan (assuming the new plan accepts rollovers), the five-year waiting period for your new plan starts instead with the year you made your first contribution to the earlier plan.
If your distribution isn’t qualified (for example, if you receive a payout before the five-year waiting period has elapsed), the portion of your distribution that represents investment earnings on your Roth contributions will be taxable, and will be subject to a 10 percent early distribution penalty unless you’re 59½ or another exception applies. You can generally avoid taxation by rolling all or part of your distribution over into a Roth IRA or into another employer’s Roth 401(k) or 403(b) plan, if that plan accepts Roth rollovers. (State income tax treatment of Roth 401(k) contributions may differ from the federal rules.)
If you contribute to both a Roth 401(k) and a Roth IRA, a separate five-year waiting period applies to each. Your Roth IRA five-year waiting period begins with the first year that you make a regular or rollover contribution to any Roth IRA.
What about employer contributions?
Employers don’t have to contribute to 401(k) plans, but many will match all or part of your contributions. Your employer can match your Roth contributions, your pretax contributions, or both. But your employer’s contributions are always made on a pretax basis, even if they match your Roth contributions. That is, your employer’s contributions, and investment earnings on those contributions, are not taxed until you receive a distribution from the plan. Your 401(k) plan may require up to 6 years of service before you fully own employer matching contributions. (Note: If your plan is a SIMPLE 401(k) plan, a safe-harbor 401(k) plan, or includes a qualified automatic contribution arrangement (QACA) your employer is required to make a contribution on your behalf, and special vesting rules apply.)
Should I make pretax or Roth 401(k) contributions?
When you make pretax 401(k) contributions, you don’t pay current income taxes on those dollars (which means more take-home pay compared to an after-tax Roth contribution of the same amount). But your contributions and investment earnings are fully taxable when you receive a distribution from the plan. In contrast, Roth 401(k) contributions are subject to income taxes up front, but qualified distributions of your contributions and earnings are entirely free from federal income tax.
Which is the better option depends upon your personal situation. If you think you’ll be in a similar or higher tax bracket when you retire, Roth 401(k) contributions may be more appealing, since you’ll effectively lock in today’s lower tax rates. However, if you think you’ll be in a lower tax bracket when you retire, pretax 401(k) contributions may be more appropriate. Your investment horizon and projected investment results are also important factors. A financial professional can help you determine which course is best for you.
Whichever you choose–Roth or pretax–make sure you contribute as much as necessary to get the maximum matching contribution from your employer. This is essentially free money that can help you reach your retirement goals that much sooner.
What happens when I terminate employment?
When you terminate employment you generally forfeit all contributions that haven’t vested. “Vesting” means that you own the contributions. Your contributions, Roth and pretax, are always 100 percent vested. But your 401(k) plan may require up to 6 years of service before you fully vest in employer matching contributions (although some plans have a much faster vesting schedule).
When you terminate employment you can generally leave your money in your 401(k) plan until the plan’s normal retirement age (typically age 65). However, the plan may be able to “cash you out” if your vested balance is $5,000 or less. But if your payment is more than $1,000, the plan must generally roll your funds into an IRA established on your behalf, unless you elect to receive your payment in cash. (This $1,000 limit is determined separately for your Roth 401(k) account and the rest of your funds in the 401(k) plan.)
You can also roll all or part of your Roth 401(k) dollars over to a Roth IRA, and your non-Roth dollars to a traditional IRA. You may also be able to roll your funds into another employer’s plans that accepts rollovers.
What else do I need to know?
Like pretax 401(k) contributions, your Roth 401(k) contributions and investment earnings can generally be paid from the plan only after you terminate employment, attain age 59½, become disabled, or die.
You may be eligible to borrow up to one half of your vested 401(k) account, including your Roth contributions, (to a maximum of $50,000) if you need the money.
You may be able to make a hardship withdrawal if you (or your spouse, dependents, or plan beneficiary) have an immediate and heavy financial need. But this should be a last resort–a 10 percent penalty may apply to the taxable amount if you’re not yet age 59½, and you may be suspended from plan participation for 6 months or more.
Unlike Roth IRAs, you must begin taking distributions from a Roth 401(k) plan after you reach age 70½ (or in some cases, after you retire), but you can generally roll over your Roth 401(k) dollars into a Roth IRA if you don’t need or want the lifetime distributions.
Depending on your income, you may be eligible for an income tax credit of up to $1,000 for amounts you contribute to the 401(k) plan.
Your assets are fully protected from creditors in the event of your, or your employer’s, bankruptcy.
Employers aren’t required to make Roth contributions available in their 401(k) plans. So be sure to ask your employer if they are considering adding this exciting new feature to your 401(k) plan.
Article Written By: Forefield Inc.
Neither Forefield Inc. nor Forefield Advisor provides legal, taxation, or investment advice. All content provided by Forefield is protected by copyright. Forefield claims no liability for any modifications to its content and/or information provided by other sources.
For professional investment advice on this topic contact: Allgen Financial Services, Inc.
888.6ALLGEN (888) 625-5436
advisors@allgenfinancial.com www.allgenfinancial.com
The recent economic downturn has created real challenges with respect to financial goals, specifically retirement goals. As many have witnessed a severe decrease of their portfolio values, the issue as to the ability to retire when expected or planned is being challenged. The truth of the matter is that there are four main components of the retirement decision:
1) How much will I need or desire?
2) When do I want to retire?
3) How much have I already accumulated
These three components work together regarding the reality of obtaining retirement goals; if one is affected or changed, the other two are impacted as well. In our current situation, the third (how much have I accumulated) has changed for many investors (for the most part decreased). This being the case, there are basically four decisions that now many Americans face, and those are to either:
1) Retire later
2) Live on less in retirement
3) Save more for retirement
4) Pursue more aggressive returns
The nature of how these are chosen obviously depends on each individual situation as personal risk tolerance, time horizons and cash flow situations will vary. However, it is prudent to take a serious look at the above mentioned variables in the quest for retirement as severe changes in a portfolio value obviously create the need for intense analysis and redesign of any previous investment strategies. Many investors, weather it be those participating in 401Ks, IRAs or other investment vehicles, tend to drive investment decisions based on fear during times of extreme market volatility. This may lead to anything from selling out completely and staying in cash for too long or deciding to not even look at what is going on with their money. The last thing one should be doing is hiding the statement in hopes that the portfolio will eventually come back. For while this may be true, one should not leave one’s financial future to the strategy of “Hope.”
Although distributions from a Roth 401(k) or Roth 403(b) account have always been eligible for rollover into a Roth IRA (in two steps–by first rolling the distribution over into a traditional IRA, and then converting the traditional IRA to a Roth IRA), the Pension Protection Act of 2006 now (in 2008) allows employees participating in traditional (non-Roth) qualified plans (e.g., 401(k), 403(b), governmental 457(b)) to rollover directly into a Roth IRA for distributions received after December 31, 2007.
Only direct (trustee to trustee) rollovers qualify (e.g., 60-day indirect rollovers do not).
Generally, the same rules apply to these rollovers as do to conversions of traditional IRAs to Roth IRAs (rollover includible in gross income (except after-tax contributions), and no 10% early distribution tax).
Taxpayers with AGI of at least $100,000 or who are married filing separately, are not eligible for this direct rollover to a Roth. These limitations were repealed by the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), but not until 2010.
For professional investment advice on this topic contact: Allgen Financial Services, Inc.
888.6ALLGEN (888) 625-5436
advisors@allgenfinancial.com www.allgenfinancial.com
Although distributions from a Roth 401(k) or Roth 403(b) account have always been eligible for rollover into a Roth IRA (in two steps–by first rolling the distribution over into a traditional IRA, and then converting the traditional IRA to a Roth IRA), the Pension Protection Act of 2006 now (in 2008) allows employees participating in traditional (non-Roth) qualified plans (e.g., 401(k), 403(b), governmental 457(b)) to rollover directly into a Roth IRA for distributions received after December 31, 2007.
Only direct (trustee to trustee) rollovers qualify (e.g., 60-day indirect rollovers do not).
Generally, the same rules apply to these rollovers as do to conversions of traditional IRAs to Roth IRAs (rollover includible in gross income (except after-tax contributions), and no 10% early distribution tax).
Taxpayers with AGI of at least $100,000 or who are married filing separately, are not eligible for this direct rollover to a Roth. These limitations were repealed by the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), but not until 2010.
For professional investment advice on this topic contact: Allgen Financial Services, Inc.
888.6ALLGEN (888) 625-5436
advisors@allgenfinancial.com www.allgenfinancial.com
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