There are many options available to allow you to invest for retirement. Depending on your work situation and income, you may be able to invest through your employer or on your own. Investment options vary greatly from plan to plan and are at the discretion of the investment firm where the plan is held. Investment options may include mutual funds, stocks, bonds, bond funds, CDs, annuities or company stock.
Regular 401(k)
A regular 401(k) plan is a retirement plan offered by employers. Money is contributed pre-tax by the employee, employer or both. The contributions are not subject to income tax withholding in the year they are made but are subject to Social Security, Medicare and federal unemployment taxes. The maximum elective deferrals for 2010 are $16,500. Participants older than 50 years old can contribute an additional $5,500. Money in a 401(k) is subject to income tax at the point of withdrawal. Funds withdrawn before the age of 59 1/2 are subject to a penalty of 10 percent and income taxes unless an exception applies. Many plans allow investors to take a loan on the elective contributions, which must be paid back. Note that a loan taken out on a 401(k) must often be repaid in full very quickly if you leave a job for any reason. Plans like this offered at nonprofit institutions are referred to as 403(b) plans but work in the same way.
Traditional IRA
An Individual Retirement Account (IRA) is a retirement fund that is offered outside of an employer. You can fund an IRA if you received taxable compensation during the year and were not 70 1/2 by the end of the year. IRAs are set up through financial institutions. The maximum contribution between all IRAs in 2010 is $5,000. Contributions to traditional IRAs, like contributions to traditional 401(k) plans, are tax deferred. This means you can deduct the amount you contribute from your income tax and pay taxes on the money when it is withdrawn. The maximum amount you can deduct from income tax for a traditional IRA is reduced the higher your Modified Adjusted Gross Income (MAGI). People older than 50 can contribute an additional $1,000. This may be reduced based on MAGI.
Roth 401(k)
Starting in 2006, employers were able to permit employees to designate elective contributions as Roth contributions to be held in a separate Roth account. These plans are funded with post-tax dollars. Limits on contributions are the same as those for regular 401(k) plans and there is no income limit. Employer contributions made to a Roth 401(k) are made pre-tax, held in a separate account, and are subject to income tax at the time of withdrawal. Early distributions from a Roth 401(k) are subject to similar regulations, with the exception that income tax will not be paid on the amount of the withdrawal that is proportionate to your after-tax contributions.
Roth IRA
Roth IRA contributions are subject to income tax. Distributions made at least five years after the first contribution and after the age of 59 1/2 or because of disability or after the participant's death, then excluded from income tax. A unique benefit of the Roth IRA is that contributions, but not gains, can be withdrawn at any time. Another type of IRA exists, called a SIMPLE IRA. This type of IRA is set up by employers who do not have 401(k) plans; contributions can be made by employer and employee. Contributions to Roth and traditional IRA plans are counted toward the annual IRA maximum contribution amount. The maximum contribution you can make to a Roth IRA may be less than the maximum depending on your MAGI.
Moving Funds
Money in an IRA account can be transferred from one financial institution to another at any time. It is best to contact the institution you are transferring to for guidance, so you do not make a mistake that could lead to penalties and taxes. Once you leave a job, for any reason, you will need to determine what to do with the money in your 401(k) plan. You may withdraw the money, which will likely subject you to penalties and income tax, you may keep the money in your former employer's account, you may move the money into your new employer's 401(k) plan or you can do an IRA rollover. Traditional 401(k) plans can be rolled into traditional IRAs, while Roth 401(k) plans can be rolled over into Roth IRAs.
Minimum Distribution
Distribution requirements also vary depending on Roth or non-Roth status. Both traditional 401(k) and IRA accounts require you to start required minimum distributions once you reach 70 1/2 years old. This amount is determined by what you have in your account, and your life expectancy, according to the IRS. Funds in Roth 401(k) and IRA plans can remain in accounts as long as you like because no minimum distributions are required.
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