Retirement Planning For 20-Somethings: Saving Options
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  1. Retirement Planning For 20-Somethings: Introduction
  2. Retirement Planning For 20-Somethings: When You Should Start Planning
  3. Retirement Planning For 20-Somethings: Goal Setting
  4. Retirement Planning For 20-Somethings: Saving Options
  5. Retirement Planning For 20-Somethings: Choosing Savings Accounts
  6. Retirement Planning For 20-Somethings: How Much Should You Add To Your Retirement Nest Egg?
  7. Retirement Planning For 20-Somethings: Signing Up For Retirement Savings Accounts
  8. Retirement Planning For 20-Somethings: Choosing And Managing Your Investments
  9. Retirement Planning For 20-Somethings: Incorporating Lifecycles In Your Planning
  10. Retirement Planning For 20-Somethings: Retirement Resources
  11. Retirement Planning For 20-Somethings: Conclusion
Retirement Planning For 20-Somethings: Saving Options

Retirement Planning For 20-Somethings: Saving Options

For the most part, you will be responsible for adding amounts to your retirement nest egg. However, if you work for an employer that provides benefits under a retirement plan, you may be able to get funding from your employer as well. The following are some of the options available to you:

Regular Savings Account: Short Term and Long Term Savings
Regular savings are usually subject to flexible contribution and distribution rules, which allow you to add as much as you want, and withdraw as much as you want at any time. However, some may apply penalties for frequent withdrawals. For instance, a financial institution may allow you to make up to three withdrawals per month at no charge, but charge a fee for every subsequent withdrawal that occurs for the month. As such, you want to ensure that you choose your savings account based on the purpose for which it is intended.

Short-term savings should be added to accounts for which there are no restrictions on withdrawals. Such an account can be used to cover unplanned expenses that may occur that you are unable to cover with your income. The rates of return on these amounts are usually very low; however, that is usually not a deterring factor as the primary objective of these accounts is to protect your principal amount from market losses.

Long-term savings can be added to savings accounts which provide a higher rate of return than what is available for your short-term savings account. This includes money market accounts, certificates of deposits and brokerage accounts in which you can have a broad range of investments. These accounts are usually recommended for items such as:

  • Big ticket items, such as appliances, that you want to save towards instead of purchasing on credit, thus allowing you to avoid avoiding paying interest and allowing you to save more
  • Down payment on a home
  • Down payment on a car or the entire cost
  • Vacation expenses
Amounts in these long-term savings accounts can also be used towards funding your retirement nest egg. In addition to regular savings accounts, your long-term savings can be added to retirement savings accounts, such as the following:

IRAs
Individual retirement accounts (IRAs) are specifically designed for retirement, and, as such, rules are in place to discourage withdrawals before retirement. For example, distributions are subject to penalties if they occur before you reach age 59.5, unless you qualify for an exception. You have two options for saving in an IRA: traditional IRA and Roth IRA. The following are some of the rules that apply to these accounts:

Traditional IRAs

  • Contributions are limited to the lesser of your taxable income (for the year) or $5,000 per year, and must be made in cash.
  • Contributions for each year are optional. However, if contributions are being made for a year, they must be made anytime between January 1 and December 31. Contributions can also be made during January 1 through to April 15 of the next year, if you designate the amounts as contributions for the previous year. If April 15 falls on a weekend or public holiday, the deadline is extended to the next business day.
  • Earnings grow tax-deferred, and are taxable when withdrawn.
  • Contributions are usually deductible on your tax return, except in cases where you are covered under a retirement plan for the year and your modified adjusted gross income (MAGI) exceeds certain amounts. The MAGI limits are as follows:
Traditional IRA Deductibility Limit for 2012
Tax Filing Status
If you are covered under an employer-sponsored retirement plan
Modified Adjusted Gross Income (MAGI)
Deduction Allowed
Single or Head of Household
No
No limit
You can deduct your entire contribution

Yes
$58,000 or less

You can deduct your entire contribution
$58,000- $68,000

You can deduct a portion of your contribution
$68,000 or more
You cannot deduct any of your contribution

Married Filing Jointly
No. Neither is your spouse
No limit
You can deduct your entire contribution
Yes
$92,000 or less
You can deduct your entire contribution
$92,000- $112,000
You can deduct a portion of your contribution
$112,000 or more
You cannot deduct any of your contribution

Married Filing Jointly
No. But your spouse is
No limit
You can deduct your entire contribution
Yes
$173,000 or less

You can deduct your entire contribution
$173,000 - $183,000
You can deduct a portion of your contribution
$183,000 or more
You cannot deduct any of your contribution

Married Filing Separately
No
Less than $10,000
You can deduct a portion of your contribution
$10,000 or more
You cannot deduct any of your contribution


You can choose to forgo claiming a deduction on your contribution even if you are eligible to claim the deduction. Non-deductible contributions are tax-free when withdrawn, but any earnings are tax-deferred and included in your taxable income when withdrawn.

  • Distributions are treated as ordinary income for the year
  • Distributions are optional until the year you reach age 70.5, at which point you must begin to take required minimum distribution (RMD) amounts on an annual basis.
Roth IRAs

  • Contributions are limited to the lesser of your taxable income (for the year) or $5,000 per year, and must be made in cash.
  • Contributions for each year are optional. However, if contributions are being made for a year, they must be made anytime between January 1 and December 31. Contributions can also be made during January 1 through to April 15 of the next year, if you designate the amounts as contributions for the previous year. If April 15 falls on a weekend or public holiday, the deadline is extended to the next business day.
  • Earnings grow tax-deferred, and are tax-free when withdrawn if distributions meet the requirements to be considered qualified distributions.
  • Contributions are not deductible
  • If your MAGI exceed certain amounts for the year, you cannot make contributions for that year. The MAGI limits are as follows:
Roth IRA Contribution Limit for 2012
Tax Filing Status
Modified Adjusted Gross Income (MAGI)
Contribution Amount Allowed
Single
$110,000 or less

You can contribute the full amount
$110,000 - $125,000

Your contribution is reduced
$125,000 or more

You cannot contribute to a Roth IRA

Married Filing Jointly
$173,000 or less

You can contribute the full amount
$173,000 -$183,000

Your contribution is reduced
$183,000 or more

You cannot contribute to a Roth IRA

Married Filing Separately
Less than $10,000
Your contribution is reduced
$10,000 or more
You cannot contribute to a Roth IRA

Roth IRA contributions are tax-free when withdrawn, and earnings are tax-deferred. If distributions meet requirements to be considered qualified distributions, the distribution of earnings is tax-free.

  • Distributions are treated as ordinary income for the year
  • RMD rules do not apply to Roth IRA owners.
The $5,000 contribution limit applies on a per-individual basis, which means that regardless of the amount of IRAs you may have, your aggregate contributions for the year cannot exceed $5,000. The $5,000 can be split between your traditional and Roth IRAs, assuming you are eligible to contribute to a Roth IRA. The following is a summary of the similarities and differences between a Roth and a traditional IRA. Take these into consideration when deciding which to choose.


Roth IRA
Traditional IRA
Contribution Limit

The lesser of the contribution limit in effect for the year ($5,000 for 2012) or 100% of your taxable income received for the year
The lesser of the contribution limit in effect for the year ($5,000 for 2012) or 100% of your taxable income received for the year
Note: Your $5,000 contribution can be split between a Roth and a traditional IRA. Regardless of the number of IRAs, your aggregate contribution for the year cannot exceed $5,000.
Deductibility (The deduction that you receive for an IRA contribution helps to offset the cost of the contribution.)
Contributions are never deductible.
Contributions are deductible if you are not covered by an employer-sponsored retirement plan and are not married to someone who is. If you and/or our spouse is covered by an employer-sponsored retirement plan your eligibility for deducting the contribution is based on your tax filing status and your MAGI.
Age Limit
There are no age limits
Contributions are not allowed beginning the year that you reach age 70.5
Savers Credit Eligibility
Contribution is eligible for the savers credit if your AGI is below certain amounts
Contribution is eligible for the savers credit if your AGI is below certain amounts
Income Cap
If your MAGI exceeds certain amounts, you are not eligible to make a contribution for the year
There are no income limits
Distributions and Tax Treatment
Distributions can be taken at any time. However, distributions taken before you reach age 59.5 are subject to a 10% early distribution penalty, unless you qualify for an exception.
Distributions of earnings are taxable if the distribution does not meet the requirements to be considered a qualified distribution.
Distributions can be taken at any time. However, distributions taken before you reach age 59.5 are subject to a 10% early distribution penalty, unless you qualify for an exception.
Required Minimum Distributions (RMD)
The RMD rules do not apply to Roth IRA owners. However beneficiaries must take RMDs amounts after inheriting the account.
You are required to start taking RMD amounts the year that you reach age 70.5




This comparison highlights the technical differences and similarities between these retirement accounts. However, much more is taken into consideration when choosing between the two types of IRAs. For example, while the idea of possible tax-free growth may make the Roth IRA seem appealing, making your contribution to a traditional IRA may be more suitable if you are eligible to claim a deduction and need to in order to be able to contribute the maximum amount, and/or if your current and projected tax rate suggests that you will pay less income tax over time if you choose to fund the traditional IRA. Consult with an experienced retirement professional to get assistance with making the decision.

Employer Plans
If you work for an employer that provides retirement savings as part of your benefits, you may be allowed to add amounts to your retirement nest egg under the employer-sponsored retirement plan provided by the business. Depending on the plan design, allowable contributions may include salary deferral contributions, employer-matching contributions and employer non-elective contributions. The following are some of the employer-sponsored retirement plans:

  • Simplified Employee Pension (SEP) IRAs: SEP IRAs are funded only by employers. If you work for an employer that sponsors a SEP IRA, you may receive a SEP IRA contribution if you meet the eligibility requirements. Once contributions are made to SEP IRAs, they become subject to the investment and distribution rules that apply to traditional IRAs, because the funding vehicle is a traditional IRA.
  • Savings Incentive Match Plan [DA1] for Employees (SIMPLE) IRAs: SIMPLE IRAs are funded by employers and employees. If you are eligible to participate in the plan, you have the option of making salary deferral contributions of up to $11,500 for the year. Your employer will either make a matching contribution of $1 for each $1 you defer (up to 3% of your compensation) or a non-elective contribution of 2% of your compensation. Once contributions are made to SIMPLE IRAs, they become subject to the investment and distribution rules that apply to traditional IRAs. An exception applies to distributions that occur before you reach age 59.5 if the distribution occurs earlier than two years after your SIMPLE IRA is funded; under this exception, the penalty is increased from 10% to 25%.
  • Defined Contribution and 403(b) Plans: Typically, your employer would fund your account under a defined contribution or 403(b) plan. However if the defined contribution plan is designed to include a 401(k) salary deferral feature, you would be allowed to make salary deferral contributions of up to $17,000 when you meet the plan's eligibility requirement, unless the plan caps your contribution to a lesser amount. Some employers do not make employer contributions to 403(b) and 401(k) plans, and instead only include a salary deferral feature under the plan. A 401(k) and 403(b) plan can include a Roth feature, which would allow you to choose between contributing to a Roth account, a traditional account or both.
  • Defined-Benefit Pension Plans: These plans are usually funded only with employer contributions.
The amount that can be contributed by your employer to any of these plans is usually based on your compensation, which is usually capped at $250,000 for plan contributions purposes, with the exception of matching contributions to SIMPLE IRAs. Regardless of your compensation, your total contributions for the year (employer and salary deferral combined) cannot exceed $50,000 for the year.

Your savings in SEP IRAs and SIMPLE IRAs can be withdrawn at any time, but may be subject to early distribution penalties for withdrawals that occur before you reach age 59.5. With defined contribution and defined-benefit pension plans, distributions are usually not permitted unless you meet certain requirements, such as if you are no longer working for the employer.

Retirement Planning For 20-Somethings: Choosing Savings Accounts

  1. Retirement Planning For 20-Somethings: Introduction
  2. Retirement Planning For 20-Somethings: When You Should Start Planning
  3. Retirement Planning For 20-Somethings: Goal Setting
  4. Retirement Planning For 20-Somethings: Saving Options
  5. Retirement Planning For 20-Somethings: Choosing Savings Accounts
  6. Retirement Planning For 20-Somethings: How Much Should You Add To Your Retirement Nest Egg?
  7. Retirement Planning For 20-Somethings: Signing Up For Retirement Savings Accounts
  8. Retirement Planning For 20-Somethings: Choosing And Managing Your Investments
  9. Retirement Planning For 20-Somethings: Incorporating Lifecycles In Your Planning
  10. Retirement Planning For 20-Somethings: Retirement Resources
  11. Retirement Planning For 20-Somethings: Conclusion
Retirement Planning For 20-Somethings: Saving Options
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