Traditional IRA, Roth IRA, 401(k), 403(b): What's the Difference?
The earlier you begin planning for retirement, the better off you will be. However, the problem is that most people don’t know how to get started or which plan is the best vehicle to get you there.
A good retirement plan usually involves more than one type of investment account for your retirement funds. This may include both an IRA and a 401(k), allowing you to maximize your planning efforts.
If you haven’t begun saving for retirement yet, don’t be discouraged. Whether you begin through an employer sponsored plan like a 401(k) or 403(b) or you begin a Traditional or Roth IRA that will allow you to grow earnings from investments through tax deferral, it is never too late or too early to begin planning.
This article discusses the four main retirement savings accounts, the differences between them and how Saxon can help you grow your nest egg.
“A major trend we see is that if people don’t have an advisor to meet with, they tend to invest too conservatively, because they are afraid of making a mistake,” said Kevin Hagerty, a Financial Advisor at Saxon Financial.
“Then the problem is they don’t revisit it, and if you’re not taking on enough risk you’re not giving yourself enough opportunity for growth. You run the risk that your nest egg might not grow to what it should be.”
“Saxon is here to help people make the best decision on how to invest based upon their risk tolerance. We have methods to determine an individual’s risk factors, whether it be conservative, moderate or aggressive, and we make sure to revisit these things on an ongoing basis.”
Traditional IRA vs. Roth IRA
Who offers the plans?
Both Traditional and Roth IRAs are offered through credit unions, banks, brokerage and mutual fund companies. These plans offer endless options to invest, including individual stock, mutual funds, etc.
Eligibility
Anyone with Earned, W-2 Income from an employer can contribute to Traditional or Roth IRAs, as long as you do not exceed the maximum contribution limits. However, only qualified distributions from a Roth IRA are tax-free.
In order to be able to contribute to a Roth IRA, you must have taxable income and your modified adjusted gross income is either:
- less than $194,000 if you are married filing jointly
- less than $122,000 if you are single or head of household
- less than $10,000 if you’re married filing separately and you lived with your spouse at any time during the previous year.
Tax Treatment
With a Traditional IRA, typically contributions are fully tax-deductible and grow tax deferred. So when you take the money out at retirement, it is taxable. With a Roth IRA, the contributions are not tax deductible but grow tax deferred. So when the money is taken out at retirement, it will be tax free.
“The trouble is nobody knows where tax brackets are going to be down the road in retirement. Nobody can predict with any kind of certainty because they change,” explained Kevin. “That’s why I’m a big fan of a Roth.”
A Roth IRA can be a win-win situation from a tax standpoint. Whether the tax brackets are high or low when you retire, it doesn’t matter. Your money will be tax free when you withdraw it. Another advantage is, at 70 ½, you are not required to start taking money out. “We’ve seen Roth IRAs used as an Estate planning tool, and they’ll be able to take that money out tax free. It’s an immense gift,” Kevin said.
Maximum Contribution Limits
Contribution limits between the Traditional and Roth IRAs are the same; the maximum contribution is $6,000, or $7,000 for participants 50 and older.However, if your earned income is less than $6,000 in a year, say $4,000, that is all you would be eligible to contribute.
“People always tell me, ‘Wow, $6,000, I wish I could do that. I can only do $2,000.’ Great, do $2,000,” said Kevin. “I always tell people to do what they can and then keep revisiting it and contributing more when you can. If you increase a little each year, you will be contributing $6,000 eventually and not even notice.”
Withdrawal Rules
With a Traditional IRA, withdrawals can begin at age 59 ½ without a 10% early withdrawal penalty but still with Federal and State taxes. The IRS will mandate that you begin withdrawing at age 70 ½.
Even though most withdrawals are scheduled for after the age of 59 ½, a Roth IRA has no required minimum distribution age and will allow you to withdraw contributions at any time. For example, if you have contributed $15,000 to a Roth IRA, but the actual value of it is $20,000 due to growth, then the contributed $15,000 could be withdrawn with no penalty, any time – even before age 59 ½.
Employer Related Plans – 401(k) & 403(b)
A 401(k) and a 403(b) are theoretically the same thing; they share a lot of similar characteristics with a Traditional IRA as well.
Typically, with these plans, employers match employee contributions, such as .50 on the dollar up to 6%. The key to this is to make sure you are contributing anything you can to receive a full employer match.
Who offers the plans?
One of the key differences with these two plans lies in whether the employer is a for-profit or non-profit entity.
These plans will have a number of options of where to invest, often a collection of investment options selected by the employer.
Eligibility
401(k)’s and 403(b)’s are open to all employees of the company for as long as they are employed there. If an employee leaves the company they are no longer eligible for these plans since 401(k) or 403(b) contributions can only be made through pay roll deductions. However, you can roll it over into an IRA and then continue to contribute on your own.
Only if you take possession of these funds would you pay taxes on them. If you have a check sent to you and deposit it into your checking account – you don’t want to do that.
Then they take out federal and state taxes and tack on a 10% early withdrawal penalty if you are not age 59 ½. It can be beneficial to roll a 401(k) or 403(b) left behind at a previous employer over to an IRA so it is in your control, and you have increased investment options.
Tax Treatment
Contributions are made into your account on a pretax basis through payroll deduction.
Maximum Contribution Limits
The maximum contribution is $19,500, or $26,000 for participants 50 and older.
Depending on the employer, some 401(k) and 403(b) plans provide loan privileges, providing the employee the ability to borrow money from the employer without being penalized.
Withdrawal Rules
In most instances, comparable to a Traditional IRA, withdrawals can begin at age 59 ½ without a 10% early withdrawal penalty. The IRS will mandate that you begin withdrawing at age 70 ½. Contributions and earnings from these accounts will be taxable as ordinary income. There are certain circumstances when one can have penalty free withdrawals at age 55, check with your financial or tax advisor.
In Conclusion…
“It is important to make sure you are contributing to any employer sponsored plan available to you, so you are receiving the full employer match. If you have extra money in your budget and are looking to save additional money towards retirement, that’s where I would look at beginning a Roth IRA. Then you can say you are deriving the benefits of both plans – contributing some money on a pretax basis, lowering federal and state taxes right now, getting the full employer contribution match and then saving some money additionally in a Roth that can provide tax free funds/distributions down the road,” finished Kevin.
To learn more, contact Kevin Hagerty today at (513) 333-3886 or via email at khagerty@gosaxon.com.
Bringing the knowledge of our in-house advisors right to you...
How to Find an Old 401(k) — and What to Do With It
According to the U.S. Government Accountability Office, there are more than 25 million people with money left behind in a previous employer-sponsored retirement plan. Read this blog post from NerdWallet for information on how to find an old retirement plan and what to do with it.
There are billions of dollars sitting unclaimed in ghosted workplace retirement plans. And some of it might be yours if you’ve ever left a job and forgotten to take your vested retirement savings with you.
It happens. A lot.
The U.S. Government Accountability Office reports that from 2004 through 2013, more than 25 million people with money in an employer-sponsored retirement plan like a 401(k) left at least one account behind after their last day on the job.
But no matter how long the cobwebs have been forming on your old 401(k), that money is still yours. All you have to do is find it.
Following the money
Employers will try to track down a departed employee who left money behind in an old 401(k), but their efforts are only as good as the information they have on file. Beyond providing 30 to 60 days notice of their intentions, there are no laws that say how hard they have to look or for how long.
If it’s been a while since you’ve heard from your former company, or if you’ve moved or misplaced the notices they sent, there are three main places your money could be:
- Right where you left it, in the old account set up by your employer.
- In a new account set up by the 401(k) plan administrator.
- In the hands of your state’s unclaimed property division.
Here’s how to start your search:
Contact your old employer
Start with your former company’s human resources department or find an old 401(k) account statement and contact the plan administrator, the financial firm that held the account and sent you updates.
"You may be allowed to leave your money in your old plan, but you might not want to."
If there was more than $5,000 in your retirement account when you left, there’s a good chance that your money is still in your workplace account. You may be allowed to leave it there for as long as you like until you’re age 70½, when the IRS requires you to start taking distributions, but you might not want to. Here’s how to decide whether to keep your money in an old 401(k).
Plan administrators have more leeway with abandoned amounts up to $5,000. If the balance is $1,000 or less, they can simply cut a check for the total and send it to your last known address, leaving you to deal with any tax consequences. For amounts more than $1,000 up to $5,000, they’re allowed to move funds into an individual retirement account without your consent. These specialty IRAs are set up at a financial institution that has been federally authorized to manage the account.
The good news if a new IRA was opened for the rollover: Your money retains its tax-protected status. The bad: You have to find the new trustee.
Look up your money’s new address
If the old plan administrator cannot tell you where your 401(k) funds went, there are several databases that can assist:
- A good place to start is with the Department of Labor’s abandoned plan database.
- FreeErisa also maintains a rundown of employee benefit plan paperwork.
- If you were covered under a traditional pension plan that was disbanded, search the U.S. Pension Guaranty Corp. database of unclaimed pensions.
- There’s also the National Registry of Unclaimed Retirement Benefits, which works like a “missed connections” service whereby companies register with the site to help facilitate a reunion between ex-employees and their retirement money. Not every company is registered with this site, so if none of these searches yields results, move on to the next step.
Search unclaimed property databases
If a company terminates its retirement plan, it has more options on what it’s allowed to do with the unclaimed money, no matter what the account balance.
"If your account was cashed out, you may owe the IRS."
It might be rolled into an IRA set up on your behalf, deposited at a bank or left with the state’s unclaimed property fund. Hit up missingmoney.com, run in part by the National Association of Unclaimed Property Administrators, to do a multistate search of state unclaimed property divisions.
Note that if a plan administrator cashed out and transferred your money to a bank account or the state, a portion of your savings may have been withheld to pay the IRS. That’s because this kind of transfer is considered a distribution (aka cashing out) and is subject to income taxes and penalties. Some 401(k) plan administrators withhold a portion of the balance to cover any potential taxes and send you and the IRS tax form 1099-R to report the income. Others don’t, which could leave you with a surprise IRS IOU to pay.
What to do with it
You might be able to leave your old 401(k) money where it is if it’s in your former employer’s plan. One reason to do so is if you have access to certain mutual funds that charge lower management fees available to institutional clients — like 401(k) plans — that aren’t available to individual investors. But you’re not allowed to contribute to the plan anymore since you no longer work there.
Reasons to move your money to an IRA or to roll it into a current employer’s plan include access to a broader range of investments, such as individual stocks and a wider selection of mutual funds, and more control over account fees.
If your money was moved into an IRA on your behalf, you don’t have to — and probably shouldn’t — leave it there. The GAO study of forced-transfer IRAs found that annual fees (up to $115) and low investment returns (0.01% to 2.05% in conservative investments dictated by the Department of Labor regulations) “can steadily decrease a comparatively small stagnant balance.”
Once you find your money, it’s easy to switch brokers and move your investments into a new IRA of your choosing without triggering any taxes.
Unless you enjoyed this little treasure hunt, the next time you switch jobs, take your retirement loot with you.
SOURCE: Yochim, D. (27 February 2019) "How to Find an Old 401(k) — and What to Do With It" (Web Blog Post). Retrieved from https://www.nerdwallet.com/blog/investing/how-to-find-an-old-401k-and-what-to-do-with-it/
Half of older Americans have nothing in retirement savings
Almost half of Americans approaching retirement have nothing saved in a 401(k) or another individual account, according to the U.S. Government Accountability Office. Read this blog post to learn more.
The bad news is that almost half of Americans approaching retirement have nothing saved in a 401(k) or other individual account. The good news is that the new estimate, from the U.S. Government Accountability Office, is slightly better than a few years earlier.
Of those 55 and older, 48% had nothing put away in a 401(k)-style defined contribution plan or an individual retirement account, according to a GAO estimate for 2016 that was released Tuesday. That’s an improvement from the 52% without retirement money in 2013.
Two in five of such households did have access to a traditional pension, also known as a defined benefit plan. However, 29% of older Americans had neither a pension nor any assets in a 401(k) or IRA account.
The estimate from the GAO, the investigative arm of Congress, is a brief update to a more comprehensive 2015 report on retirement savings in the U.S. Both are based on the Federal Reserve’s Survey of Consumer Finances.
The previous report found the median household of those age 65 to 74 had about $148,000 saved, the equivalent of an inflation-protected annuity of $649 a month.
“Social Security provides most of the income for about half of households age 65 and older,” the GAO said.
The Employee Benefit Research Institute estimated earlier this month that 41% of U.S. households headed by someone age 35 to 64 are likely to run out of money in retirement. That’s down 1.7 percentage points since 2014.
EBRI found these Americans face a combined retirement deficit of $3.83 trillion.
SOURCE: Steverman, B.; Bloomberg News (27 March 2019) "Half of older Americans have nothing in retirement savings" (Web Blog Post). Retrieved from https://www.employeebenefitadviser.com/articles/half-of-older-americans-have-no-retirement-savings
Average worker needs to save 15% to fund retirement
Originally posted July 22, 2014 by Nick Thornton on https://www.benefitspro.com
A typical household needs to save roughly 15 percent of their income annually to sustain their lifestyle into retirement, according to a brief from the Center for Retirement Research at Boston College.
Generally, workplace retirement savings plans should provide one-third of retirement income, according to the study. For lower income families, defined contribution or defined benefit plans should provide a quarter of all retirement income. Higher income families will need their retirement plans to provide about half of all retirement income.
Middle-income families will require 71 percent of pre-retirement income to maintain living standards after they leave the workforce. About 41 percent of their retirement income is expected to come from social security.
Low-income families need an annual savings rate of 11 percent in order to sustain their lifestyle into retirement, which is lower than middle-income families (15 percent) and high-income families (16 percent). For lower income families, social security will replace a greater portion of pre-retirement income.
The Center’s National Retirement Risk Index says that half of Americans lack adequate savings to maintain their standard of living into retirement. A “feasible increase” in savings rates by younger workers can greatly affect their retirement wealth.
For those middle-income workers ages 30 to 39 who lack enough savings, a 7 percent increase in annual savings can provide adequate retirement funding. But middle-income workers age 50 to 59 who lack retirement savings would have to increase their annual savings rate by 29 percent, an unlikely expectation, the report adds.
For those older workers behind the curve, a better funding strategy would be “to work longer and cut current and future consumption in order to reduce the required saving rate to a more feasible level.”
Delaying retirement to age 70 greatly reduces the annual savings expectations workers need to meet in order to fund retirement.
A worker who starts saving at age 35 will need a 15 percent annual savings rate in order to retire at age 65. But if the same worker delays retirement until age 70, only a six percent annual savings rate is necessary.
A worker who starts saving at age 45 would need to save 27 percent annually to retire at 65. But by delaying retirement to age 70, the same worker only has to save 10 percent to maintain their standard of living after retirement.
Retirement confidence rebounds from five-year lull
Originally posted March 18, 2014 by Michael Giardina on https://ebn.benefitnews.com
Retirement confidence among Americans regained some of the losses reported over the past five years – where approximately 18% are very confident and 37% are somewhat confident with the future financial needs – according to a new survey from the Employee Benefit Research Institute.
In its 24th installment, the EBRI annual Retirement Confidence Survey states that there was a 5% point jump in Americans workers who reported they were very confident and there was no statistical change among the population that were not at all confident at 24%.
Last year, 21% reported that they were not too confident and 28% - the highest level in the survey’s history – are not at all confident about the future needs of a comfortable retirement. 2013’s lowly sentiment also resonated with the very confident and somewhat confident, which reported 13% and 38% markers, respectively.
The Washington, D.C.-based nonpartisan, nonprofit research organization states that there was a 10% jump in worker confidence with a retirement plan who report being very confident at 24%. For the cohort without a retirement plan, the very confident level dipped down one percentage point to 9%.
“Retirement confidence is strongly related to retirement plan participation,” says Jack VanDerhi, EBRI research director and co-author of the 2014 report. “In fact, workers reporting that they or their spouse have money in a defined contribution plan or IRA or have a defined benefit plan from a current or previous employer are more than twice as likely as those without any of these plans to be very confident.”
The findings indicate that 1 in 10 of participant households currently enrolled in a retirement plan were listed as being not at all confident. At the same time, half of respondents without a retirement plan reported the same confidence level.
While 64% of workers report that they or their spouses have saved for retirement – a statistically equivalent figure to 2013 – 90% of workers currently signed up to a retirement plan list they have saved for their future income needs when they exit the workforce.
Also, retiree confidence, typically higher than worker confidence levels, continues to climb in 2014. Twenty-eight percent felt were very confidence in their financial security, a 10% jump from 2013.
Roughly half of participants state that financial hurdles such as the cost-of-living and daily expenses – as well as lingering debt – hinder worker savings.
“Just three percent of workers who describe their debt as a major problem say they are very confident about having enough money to live comfortably throughout retirement, compared with 29 percent of workers who indicate debt is not a problem,” says Matt Greenwald, of Greenwald & Associates, which conducted and co-sponsored the survey.
During America Saves Week earlier this year, Dallas L. Salisbury, president and chief executive officer of the EBRI and chairman of the American Savings Education Council, highlighted that employers can assist with the current savings epidemic. Salisbury explained that workers who conducted retirement-needs calculation were more confident to save what is needed for retirement. Complementing this goal, he says that the theme for this year’s America Saves Week is “to set a goal, to make a plan and to save automatically.”
Other findings of this year’s RCS:
- Workers acknowledge the need for savings: Approximately 22% of the sample believes that they need to save between 20-29% of their income and another 22% believe that 30% of income is warranted.
- Estimating retirement savings needs is still unpopular: Roughly 44% state that they and/or their spouse have participated in this calculation.
- Financial advice is even less popular and falls on deaf ears: one in five workers and 25% of retirees report they have sought the help of a financial adviser; Only 27% of workers and 38% of retirees say they used all of the professional’s financial advice.
How to Take Control of Your 401(k)
Originally posted August 27, 2013 by Scott Holsopple on https://money.usnews.com
A recent survey by Charles Schwab of 1,000 401(k) participants said that 52 percent of those polled find their 401(k) plan more confusing than their health insurance benefits. That's pretty impressive, given that I don't think I know anyone who claims to understand their medical coverage. Fifty-seven percent desired an easier way to choose their 401(k) investments.
Despite the bad press the 401(k) plan sometimes receives for its complexity and for requiring plan participants to become investors whether they want to or not, the fact remains that it is a great way to save for retirement. For many people, it's their only retirement savings vehicle. Sure, if you don't have much interest in investing and finance, you might find it confusing to manage your account — but it's up to you to do something about it.
Being a 401(k) plan participant requires you to take charge of your retirement saving and investing, so don't let confusion or uncertainties leave you on the sideline. Instead, here are five things you can do to step up:
- Embrace the power and control you have, and think hard about how to use it. Spend some time seriously thinking about your retirement saving and investing needs. Jump on some educational websites and do some reading to familiarize yourself with basic investing terminology and the types of investments to which you have access.
- Take action by creating a retirement saving and investing plan. Outline the amount you plan to contribute now and in the future in order to reach your retirement goals.
- Take advantage of your 401(k) plan's features. Many plans offer ways to maximize your participation such as an employer match, educational resources and advisory services that can help you pick the right funds to support your retirement goals.
- Check to see if your plan offers an auto-increase contribution feature, which automatically increases your contribution rate by a small amount each year (or more frequently, if you like). If your plan doesn't offer auto-increase set up calendar reminders and increase your contributions yourself. Either way, you need to save as much as you can and regular contribution increases can help you get there.
- Once you've established your strategy, stick to it. Paying too much attention to market fluctuations can cause some investors to run scared. A long-term view is what's needed, rather than concentrating on your account balance on any one day.
The 401(k) plan might not be perfect, but you stand to gain a lot when you take advantage of being in the driver's seat — just a little know-how can make a big difference when it comes to your 401(k) and financial future.
Will U.S. workers ever be able to retire?
Original article from usatoday.com
Despite the rebound in home prices and new all-time nominal highs in the stock market, many Americans are looking at an unpleasant retirement, if they even make it that far; according to the Employee Benefit Research Institute's latest survey on retirement confidence, the majority of workers have saved for their golden years, but the piggy bank is quite slim.
Excluding the value of a primary home and any defined benefit plans, 57% of households say they have less than $25,000 in savings and investments, while 28% say they have less than $1,000. Furthermore, the Center for Retirement Research at Boston College has warned that 53% of American households are at risk of not having saved enough to maintain their living standards in retirement.
Americans are still planning for retirement, but, as one would expect, how they have saved for retirement depends very heavily on age and on pre-retirement income.
Compared to other countries' retirement systems, that of the United States doesn't stand up well. In a recent report, the Mercer consulting firm and the Australian Center for Financial Service, gave the United States a "C" grade, a rating considerably worse than the A received by Denmark and the B-plus given to the Netherlands' retirement system, which combines a Social Security-like fund with a nearly universal pension system to which employers contribute. The study showed plainly that many other countries are more willing than the United States to mandate unpleasant steps by workers and employers to fund a stable system.
The United States does have some mandates; employers must pay 6.2% of each employee's salary into Social Security, and every employee must also contribute that amount. But the Social Security system faces the threat of a huge shortfall. One-third of America's retirees get at least 90% of their retirement income from the program, with annual benefits averaging a modest $15,000 for an individual.
Another important pillar of America's retirement system, the 401k, is voluntary and generally not accessible to low-wage workers, who may not have the income necessary to invest. Although some employers have embraced automatic enrollment for their workers, more than 58% of American workers are not in a pension or 401k plan. Those employees with such plans, whose payouts are dependent on contributions and investment returns, are exposed to the risks associated with the stock market, which after the financial crisis were quite great.
The problems associated with these two primary means of saving dictate which financial sources fund the retirements of lower-wage workers and higher-wage workers. Gallup's annual Economy and Personal Finance poll, conducted between April 4 and April 14 of this year, sampled more than 2,000 adults to discover how non-retired Americans expect to fund their retirement. The results show that expectations varied significantly by annual household income. Upper-income retirees primarily said that investments, such as 401ks, or individual stock investments would fund retirement, while lower-income respondents said that Social Security and part-time work would be major sources.
In fact, of those respondents earning $75,000 or more per year, 65% said that retirement savings accounts would be the "major source" of retirement funds, and only 17% said Social Security. Comparatively, 42% of respondents earning less than $30,000 per year said Social Security would be a major source of income, 27% said work-sponsored pension plans, and another 27% said part-time work.
Younger generations of workers, particularly the 18 to 29 year-old bracket exhibited uncertainty about the future of the Social Security. Gallup found that only about one in five young adults expected to receive a Social Security benefit when they retire. Fifty-three % of respondents from the youngest age group said that they expected to fund their retirement through 401ks, while 49% said savings accounts or CDs and 24% said part-time work.
When looking at retirement strictly through the lens of age, the poll's results show the changing nature of retirement funding. Young respondents are looking to sources outside of Social Security to support them after they stop working, but those nearing retirement age now see Social Security contributing significantly to income — the program is essentially tied with 401k plans as the top source among 50 to 59-year old non-retirees, and it is the number one source among non-retirees aged 60 and older.