Common Questions About Retirement Plans

Understanding the contribution limits and tax issues that affect your retirement plans can help you not only avoid costly mistakes but also take advantage of available benefits. In most cases, individuals are well advised to consult with a competent tax professional to determine benefits that may apply to their particular situations. Here we address common questions asked by business owners and those operating employer-sponsored retirement plans, as well as questions that pertain to the individual taxpayer. (Remember, though, to consult with your tax professional should you need more specialized assistance.)

Employee With A Business
Question:
I work for a corporation that provides a 401(k) plan in which I participate. But I also provide consulting services on the side. Can I establish a retirement plan for my consulting business, and if so, how are contributions to the plan affected by my participation in my employer's retirement plan?

Answer:
You can establish a retirement plan for your business if your only affiliation with your employer is that you work for the company and have no ownership in the company. Contributions to the plan established for your consulting business are not affected by contributions made to your employer's 401(k) plan, but there is one exception. The exception applies to salary-deferral contributions.

Salary-deferral contribution limits apply on an individual (per-person) basis (rather than on a per-plan basis). This means that regardless of the number of plans in which you participate, you cannot make deferral contributions for more than the following amounts.

Tax Year	Elective-Deferral Contribution Limit
2004	$13,000
2005	$14,000
2006	$15,000
2007	$15,500
2008	$15,500
2009	$16,500

If you are at least age 50 by the end of the year, you may make catch-up contributions, in addition to the amounts indicated in the chart above. The catch-up contribution limits are as follows:

Tax Year	Catch-Up Contribution Limit
2004	$3,000
2005	$4,000
2006	$5,000
2007	$5,000
2008	$5,000
2009	$5,500

For instance, say you are 35 years old and you defer $5,000 to the 401(k) plan sponsored by your employer for 2009. You may defer no more than $11,000 ($16,500 - $5,000) to the plan you adopt for your business if it has a salary-deferral feature.

The rules for what is referred to as the annual-addition amount are different, as they apply on a per-employer basis. The annual addition rule limits a participant's contributions under a defined-contribution plan to 100% of the participant's compensation or $49,000, whichever is less. (The $49,000 limit applies to tax year 2009, but the limit is indexed for inflation in increments of $1,000. The IRS sends a notice in the last quarter of every year indicating whether the limit will increase for the next year.) This $49,000 is inclusive of salary-deferral contributions and employer contributions such as profit-sharing and matching contributions. Since the annual-addition limit applies on a per-employer basis, and your consulting business is a separate employer from the corporation with which you are regularly employed, you can contribute up to $49,000 to each plan.

Example
Say you earn $200,000 from your employer and that your employer's 401(k) plan includes a profit-sharing feature, which is a type of defined contribution. You can receive up to $49,000 (for 2009) to your 401(k) )/profit-sharing plan, which can consist of your salary-deferral contributions and employer contributions, such as profit-sharing and matching contributions.

Additionally, because the rules for the annual-addition amounts apply separately to each plan, the contributions to the retirement plan you adopt for your business can be up to $49,000, making your aggregate contribution limit $98,000, plus an additional $5,500 if you reach age 50 by year-end 2009. Bear in mind that the employer contributions, such as profit-sharing contributions, to the plan you adopt for your business are limited to 25% of W-2 wages you pay yourself if your business is incorporated, or 20% of your modified net profit if your business is a sole proprietorship or partnership, plus salary-deferral contributions. Additionally, your aggregate contributions (employer and salary deferral) to the plan you adopt for your business should not exceed 100% of the compensation you receive from your business.

The rules regarding contribution limits for multiple plans for multiple businesses are different if the businesses have a common ownership or affiliation. In such cases, individuals must consult with a competent tax professional or plan administrator to determine the applicable rules.

Making Salary-Deferral Contributions to Two Plans
Question:
If I participate in two employer-sponsored plans, can I make salary-deferral contributions to both?

Answer:
Yes. However, salary-deferral contributions are generally limited to a single aggregate amount for the year. For instance, for tax year 2009, you can make salary-deferral contributions of up to $16,500 plus an additional catch-up amount of $5,500 if you reach age 50 by December 31, 2009. This amount can be split among multiple retirement plans in which you participate, provided your aggregate salary-deferral contributions to all the plans do not exceed $16,500 plus catch-up.

An exception applies to deferrals made to 457 plans as such amounts are not classified as salary deferrals by the Internal Revenue Code. As such, if you participate in a 403(b) or 401(k) plan and you also participate in a 457 plan, you may defer $16,500 plus catch-up to the 401(k) or 403(b) plan, and the same amount to the 457 plan, provided your aggregate contributions to either plan do not exceed 100% of compensation received from the employer that sponsors the plan. For instance, your aggregate contribution to the 403(b) cannot exceed 100% of compensation you receive from the employer that maintains the 403(b) plan.

Extensions on Deadlines for IRA Contributions
Question:
I applied for an extension to file my income tax return by August 15, 2009. Can I make my 2008 IRA contribution by August 15, 2009?

Answer:
No. Tax-filing deadlines do not apply to IRA contributions. Your IRA contributions must be made by your tax-filing due date, not including extensions.

Deadline to Recharacterize IRA Contributions
Question: I contributed $3,000 to my Traditional IRA for the last tax year. I recently met with my financial planner, who explained that I am eligible for a Roth IRA contribution for the last year and that it would be more beneficial to treat the amount as a Roth IRA contribution. Since I already filed my tax return by the due date of Apr 15, can I change the contribution to a Roth contribution now in July?

Answer:
Yes. Since you filed your tax return by the due date, you receive an automatic extension of six months to recharacterize your last-year's IRA contribution. This means that your IRA custodian must receive your instructions for the recharacterization by Oct 15 of the current year. Be sure to check with the custodian to determine proper documentation requirements.

Since you already filed your last-year's tax return, and it did not include the recharacterization, you must file an amended tax return (IRS Form 1040X). Generally, Form 1040X must be filed within three years after the date you filed your original return or within two years after the date you paid your income tax, whichever is later. If you filed your tax return early, it is still treated as having been filed by your tax return due date. You should check with your tax professional or your state tax-filing authority to determine whether you need to file an amended state tax return.

Conclusion
We hope you found these questions and answers helpful. Please feel free to send us tax questions related to retirement plans that you would like us to address. Bear in mind, however, that the information above gives only general guidelines - and should not be taken as tax advice, legal advice, financial-planning services or estate-planning services. Neither Investopedia nor Denise Appleby provides tax or legal advice. Remember, individuals, businesses or any other parties should consult with their financial professional, tax professional or legal professional for advice related to their specific needs.

by Denise Appleby (Contact Author | Biography)

Denise Appleby is a retirement plans consultant, freelance writer and editor. Before starting her own business, Appleby Retirement Consulting, Denise worked for Pershing LLC for almost 10 years. While at Pershing, Denise rose to the rank of vice president, and held many positions including retirement plans product manager, manager of the retirement plans technical assistance group and retirement plans training manager. Appleby Retirement Consulting provides technical assistance to financial institutions and financial professionals; content for newsletters, websites and magazines; and technical editing services for books and other retirement plans material. Denise holds several retirement professional designations.