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  • Writer's pictureJohn Hickey

The basics of retirement savings accounts

Have you thought about what retirement investment tool is the best fit for you? There are several different types of employer sponsored retirement plans. In this blog we are going to examine three of them, the 401(k) Plan, the SIMPLE IRA, and the SEP IRA.

401(k) Plan: A 401(k) is a defined-contribution pension account that an employee allows an employee to invest a portion of their salary (up to $19,500 per year) into an investment vehicle. Employers can choose to match all or part of your investment into the plan. Typically, the 401(k) plan will offer several different funds to invest in, including mutual funds, index funds, large-cap and small-funds, and bond funds. The funds will range from aggressive growth funds to conservative income funds. There are rules form withdrawing money from a 401(k). A triggering event must occur in order for funds to be paid out. The most common triggering events include reaching the age of 59 ½ and retirement from the job. Early withdrawals are subject to a 10% penalty and you will be liable for any income tax due. If their plan permits, individuals may be able to take out a loan from their 401(k), but this loan must be paid back within 5 years or penalties and taxes will be assessed.

SIMPLE (Savings Incentive Match Plan for Employees) IRA: This is an investment tool employers may offer to help individuals save for retirement. If you are eligible to participate in a SIMPLE IRA plan, your contributions are tax deductible and grow tax free until you start making withdrawals. Similar to a 401(k), you can begin to make withdrawals at age 59 ½. Any withdrawals before that age are subject to at 10% penalty and applicable income taxes. One of the unique features of the SIMPLE IRA is that it requires a mandatory employer contribution. This is either a match of the employee contribution, up to 3%, or the employer must contribute 2% of the employee’s salary, even if the employee does not contribute. Typically, small businesses will offer the SIMPLE IRA because they are less expensive and easier to administer than a 401(k). It is worth noting that the contribution limit of $13,500 is lower than a 401(k). Also, you cannot take a loan against your investment in a SIMPLE IRA like you can with a 401(k).

SEP IRA (Simplified Employee Pension Individual Retirement Account): For self-employed workers, retirement planning has its own set of challenges. A SEP IRA, is specifically designed for individuals who are self-employed. SEP IRA accounts have the same investment options as traditional IRAs and are treated as traditional IRAs for tax purposes. Contributions made to this plan must be less than 25% of your income, but they have a higher contribution limit than traditional IRAs; $57,000 for 2020. Although you can access the funds in your SEP IRA at any time, withdrawals before the age of 59 ½ are subject to a 10% tax penalty and are included in your taxable income. Also, similar to a traditional IRA, the IRS requires you to take minimum distributions in the year you turn 72 years old. A SEP IRA does not have to be your only retirement fund account either. If your self-owned business is a side job and you have a regular employer, you can have both a 401(k) and a SEP IRA for yourself. The SEP IRA also provides an opportunity for business owners to contribute towards their employees’ retirement as well. Eligible employees are those who are over 21 years of age, have worked for the employer for 3 of the last 5 years, and they received at least $600 in compensation for the tax year. Also, the business owner must contribute the same percentage of salary to their employees’ account as they are contributing to their own.

No matter what plan is offered by your employer, or what you may decide to invest in on your own, we are here to offer you advice and guidance as you make these financial decisions. Our experience has shown us that each person has their own individual retirement goals and we are happy to start the conversation with you to help you define and work towards those goals.

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