Funding your retirement account can be achieved with either pre-tax, tax-deductible contributions, or after-tax contributions that allow you to withdraw tax-free money when you retire. It’s possible to participate simultaneously in pre-tax and after-tax retirement plans, if it’s permitted by your tax-deductible retirement plan and with the advice of your financial adviser or accountant. Those who are able to maintain both types of accounts benefit from tax-saving advantages at both ends of the spectrum.
Several studies show that about one-third of Americans aged 50-65 have no retirement savings whatsoever. Fewer than 20% feel confident that they’ll have enough money to live comfortably throughout the retirement years.
Those numbers are discouraging and I will speculate that women, who live longer and typically earn less money than men, are at a particular financial disadvantage. Poverty in our senior years is often a concern for women. While it’s become increasingly difficult to save money in America, it is imperative that each of us, and especially women, do our best to fund retirement, using either pre-tax or after-tax earnings.
The Individual 401K, or SOLO 401K, allows you to give yourself a “salary deferral” of maximum $18,000 and those aged 50 and older can utilize the $6000 “catch-up” contribution feature, which allows a maximum contribution of $54,000 in tax-deductible dollars in 2016.
After-tax dollars fund the Roth Retirement Account, or ROTH 401K. When you are ready to access the account, you will draw down tax-free money. The 2016 annual maximum annual contribution is $18,000 plus the “catch up” $6,000 for those age 50 or older. High earners appreciate this plan, as there is no annual income limit for participants.
It is permissible to use the salary-deferred portion of your SOLO 401K to make ROTH 401K contributions. Profit sharing SOLO 401K contributions are NOT eligible to be applied to a ROTH 401K, since they are made pre-tax, they’re tax-deductible and you cannot commingle the two.
While ROTH 401K contributions are not tax-deductible, withdrawals made after age 59 1/2 are tax-free if five years have passed since your first contribution (known as the 5 year rule).
Another after-tax retirement plan is the ROTH IRA. There are income limitations associated: in 2016, $132,000 for singles and $194,000 for married couples. The annual contribution limit is $5,500 and $6,500 for those age 50 and older. Your ROTH IRA may be held in tandem with your SEP, SIMPLE, or traditional IRA.
You may participate in a ROTH IRA at any age, if you continue to earn taxable income. There is no mandatory distribution age, a feature that might benefit cash-flow planning. Furthermore, a working spouse can contribute to a ROTH IRA on behalf of the non-working spouse.
An individual or couple might choose a ROTH retirement plan when there are insufficient deductions to itemize at tax time, thus negating the tax benefit of other retirement plans. ROTH, paid with after-tax dollars, gives account holders the benefit of tax-free income during retirement. Affluent Entrepreneurs who need to minimize taxes during retirement may benefit from the ROTH.
President Obama, by way of the Department of the Treasury, gives us the newest self-funded retirement account option, myRA. The plan is a ROTH IRA re-designed as a starter retirement account to encourage the process. There are no fees associated with opening a myRA account and participants can decide how much to contribute each year, according to budget. Automatic monthly or weekly contribution withdrawals can be set up through a bank account or salary paycheck.
If participants must withdraw money from the account, there is no financial penalty to pay and no additional taxes due. myRA is funded with after-tax income and strictly speaking, contributions are not tax-deductible. However, some low-income participants may qualify for a tax credit of 10% – 50% of their annual contribution.
The maximum annual myRA contribution is $5,500 and $6,500 for those age 50 or older. The maximum amount that can be held in a myRA account is $15,000. Once that limit has been reached (or before, if one decides), the fund must be rolled into a traditional retirement account.