Retirement accounts are tax-advantaged savings accounts designed to encourage investors to invest for the long term. Some of the most popular retirement accounts are Traditional and Roth Individual Retirement Accounts (IRAs), 401(k) plans and SEP-IRAs. While most retirement accounts offer similar overall tax benefits, the deductibility of contributions and the amounts you can contribute vary depending on the type of plan you choose. Wealthy individuals might be restricted from enjoying the full benefits of certain plans based on their high income level.
Deductibility of Contributions
As a wealthy individual, a primary focus of your financial planning efforts is undoubtedly the reduction of taxes. One of the main benefits of a retirement plan is that with the exception of Roth IRAs, your contributions are tax-deductible in the year you make them. If you run a business and make retirement plan contributions on behalf of your employees, those contributions are also deductible, as a business expense.
Tax-Deferred Savings
Unlike ordinary investment accounts, in which you must pay tax on any income and capital gains you generate, retirement accounts defer all taxes on your gains until you make a withdrawal. In the case of a Roth IRA, your contributions and earnings actually grow tax-free, even when you take a distribution. This can be a major benefit because if you are a wealthy individual, you are in a high tax bracket currently, and your gains would be taxed at a high rate. In fact, your gains could even push you into a higher tax bracket, if you are not already in the top bracket. With a retirement account, you will most likely withdraw your funds after you have stopped working, when you may be in a lower tax bracket.
Required Minimum Distributions
Once you reach age 70 1/2, you are required to begin taking annual minimum distributions from your retirement accounts. This is a major negative of retirement accounts for wealthy individuals, as you are forced by the IRS to draw additional taxable income when you may not even need it. This additional income may push you into a higher tax bracket as well.
Restrictions on Contributions and Deductibility
Although retirement plans offer tax-deferred savings, for a wealthy individual, the contribution and deduction limits can seem fairly low. For example, IRA contributions are capped at $5,000 for 2010, and you may not even be able to take a tax deduction if you are covered by a retirement plan at work. Roth IRA contributions cannot even be made if you have a modified adjusted gross income of over $105,000 for singles, or $176,000 for couples. While you can contribute up to $49,000 if you earn over $245,000 as a self-employed individual with a SEP-IRA plan, that is still only 20 percent savings rate.
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