Types of Accounts: Tax Deferred (Non-IRA’s)

As mentioned in a previous post, most tax deferred accounts are IRA’s, however there a few accounts that are non IRA’s and are entitled to the same tax deferred benefits. Now that we have gone over all the types of IRA’s that are available to you for retirement, let’s turn our attention to accounts that can help you and your children (if you have any) in the near future. Let’s talk about an Education Savings Account (ESA). What are they? Just as IRA’s are designed to help you for retirement, ESA’s are designed to help you with your children’s educational costs. In fact, an ESA used to be called an Education IRA. There are 2 types of accounts that help you do this, a Coverdell and a 529 Plan. Both accounts are quite different, and I will explain their differences in my next post, but for now let’s stick to their similarities. Like IRA’s, any realized gains in these accounts are not taxed. However, when a distribution is made from a Coverdell or 529 Plan, if the funds are used for higher education expenses, the realized gains in the distribution will not be taxed. Well what qualifies as a “higher education expense?” The term higher education is referring to any education sought after High School. This can be at a College or University. The term expenses refers to any costs associated with higher education. This can include tuition, room & board, textbooks, school supplies (including lap-tops), and everything in between. If its school related, it will most likely qualify.

Money in both accounts is considered the owners and not the beneficiaries (the child). This is important because the money can always be taken back out for whatever reason, no questions asked. Additionally, contributions can be made by any party; they don’t have to be listed on the account or even directly related to the child. Furthermore, the account can be transferred to another beneficiary (considered a Rollover) without incurring taxes or penalties, but they must be a qualified family member. Consult your advisor or authorized dealer to determine who is considered qualified. Now that we have gone over their similarities, in my next post I will discuss how Coverdell’s and 529 Plan’s differ from one another.

Types of Accounts: 401(k) & 403(b) Differences

• 401(k): are offered by for profit companies, including sole proprietorships, partnerships, corporations, and even government entities. Administrative costs are usually higher than a 403(b).
• 403(b): are offered by nonprofit companies, religious groups, school districts, governmental organizations, and any other foundations that fall under Section 501(c)(3) of the Internal Revenue Code. Due to this fact, administrative costs are lower, allowing for organizations with very small budgets to help their employees save for retirement.

When you leave your employer, your 401(k) & 403(b) plans usually leave with you. In most cases this is determined on the conditions of your exit from the company. An example of when you may be denied your right to take it with you is if you were dishonorably discharged. Once you have determined you are eligible to take your plan with you, you now have the task of “rolling it over” into an IRA. You are no longer required to keep it with your current provider; you can now take it to your existing brokerage firm (if you have one) or with any firm that offers IRA’s. If you don’t already have a brokerage firm and need to begin looking for one, as mentioned in my earlier posts, you should find one that best fits your investment goals.

Once you have made a decision in picking a firm, you can now roll your 401(k) and/or your 403(b) into an IRA. This deposit won’t be labeled as a contribution, instead it will be labeled as a Direct Rollover, which means the funds are coming from an employer sponsored account. This is not to be confused with a regular Rollover, as that is when funds come from one IRA and are rolled into another IRA. In order to begin the process of rolling your plan into your new IRA you must first open an IRA with your brokerage firm. Once this has been done, inform your current plan provider you would like to rollover your 401(k)/403(b) into your new IRA. They will send you a form asking for the address of the firm, the account title of the IRA, and the account number among other things. Once you return the form to your plan provider, they will (in most cases) liquidate (which means sell) all positions you have in the account and either mail you the check, or directly mail it to your new brokerage firm. Your new brokerage firm will then process your deposit, and the funds will be available for you to invest with.

 

It’s important to note rollovers are typically done into a Traditional IRA, but they can be done into Roth’s. However, if done into a Roth, the rollover is subject to be taxed since Roth’s contain after-taxed dollars.

Types of Accounts: 401(k) & 403(b) Similarities

A 401(k) & 403(b) are employee sponsored accounts, thus your employer must offer them to be an eligible participant. They are both retirement accounts, hence are tax-deferred, and contain pre-taxed dollars. In essence they are very much like Traditional IRA’s (in reality they are categorized as Traditional due to this fact). Unlike a Traditional, these retirement accounts are administered by a financial management company chosen by your employer (or one of several they will allow you to choose from) and you select which investments you would like to pursue. However the investments available to choose from are limited. Since the account is designed for retirement, the investments available are naturally conservative. This means individual stocks aren’t typically available to invest in, neither are ETF’s or Options (which I will get into later). This is due to their volatility and the risks associated with these investments. Some investments typically available in these accounts are Mutual Funds (also explained later), Bonds, and Annuities. These investments are usually much more secure, meaning they aren’t as volatile, making them perfect for retirement accounts.

Unlike Traditional IRA’s however, these accounts are automatically funded by your employer through your paycheck. How is this done? When signing up for a 401(k) or 403(b) through your employer, you will be asked how much of your paycheck you would like to designate into your retirement account. A percentage of your paycheck, rather than a fixed dollar amount, is the typical method of funding. There are contribution caps associated with these accounts and are typically determined by your income. In many cases employers will match any contributions you make into your retirement accounts like SIMPLE’s, however they aren’t required and can be in any ratio. Some companies match dollar-for dollar, 50 cents for each dollar, and some may not offer any matching at all. Now that we have gone over how a 401(k) & 403(b) are similar, let’s go over their differences.

Types of Accounts: SIMPLE Explained

• SIMPLE: is the newest type of IRA. It’s very similar to a SEP, yet has many more limitations. Savings Incentive Match Plans for Employees of Small Employers (SIMPLE) are intended for small businesses, as you may have noticed based on its title, and requires employers to match employee contributions. Well what constitutes as a small business? To qualify, the company must employ 99 or fewer employees who earn at least $5k per year. The company must also match each employee’s contribution dollar-for-dollar up to 3% of each participating employee’s salary. Companies can also make fixed contributions of 2% of each eligible employee’s salary, regardless if the employee is enrolled. Thus, unlike SEP’s, employees are encouraged to make their own contributions because employers are able to match them, but if they do choose not to pursue an IRA, employers can still make contributions on their behalf. Who doesn’t want free money!? However, like all good things, there is a catch. SIMPLE’s have stricter rules regarding early withdrawals and tax-free rollovers compared to other IRA’s. For example, if a distribution is made before the SIMPLE has been open for 2 years; a penalty of 25% will be charged to the account, unlike the 10% penalty fees seen in other IRA’s. Like SEP’s, employer's receive tax deductions for their contributions, and all contributions are immediately 100% vested.

As you can see both SEP’s & SIMPLE’s offer very similar benefits for both employers and employees. They are both designed to encourage businesses to offer retirement plans for their employees as well as facilitate the process. Next we’ll look at retirement plans provided by the government and many corporations that are available to its employees.

Happy Thanksgiving. No Work, No School, Just Family Fun!

This is a special post for all my followers in wishing them a Happy Thanksgiving. I hope everyone is spending it with their family and will be enjoying the oven roasted turkey that has been prepared for this evening, and if you don’t eat turkey, I’m sure you will love your meal just as much. Nothing beats having a big dinner at home with your family. I know I’m looking forward to tonight’s dinner, although I must admit I’ll probably over eat as I do every year! Guess I’ll have to hit the track sooner and for a longer period of time, but it will soooo be worth it!

Anyhow, let’s get back to the task at hand, investing! As you may know, along with schools being closed, the government and many other institutions are closed as well. However, just because the government is closed on holidays does not suggest the market is always closed. Thus I have provided a list of holidays in which the market is closed, while outlining the holidays the market is open even though banks and the government may be closed. Unfortunately for me, if the market is open, my company is open for business, and thus I am required to go in. Although this is a bit of a drag, there is one holiday in which the market is closed but the government and banks are open. Can you guess which holiday? Check below to find out, and see if you can spot the missing holiday(s). The following are market holidays:

• New Year’s Day       • Martin Luther King, Jr. Day      • Presidents Day
• Good Friday             • Memorial Day                             • Independence Day
• Labor Day                 • Thanksgiving Day                       • Christmas Day

The stock market has 3 trading sessions, a pre-market, normal market, and after-market. The Pre-Market hours are from 7am to 9:29am, Market from 9:30am to 4pm, and After-Market from 4:01pm to 8pm. Pre-Market & After-Market hours don’t see too much trading, thus not all stocks trade during these hours, only the major heavy volume stocks. In addition to the above closures, the market closes early (at 1:00 PM ET) on the day before Independence Day and Christmas Day, as well as the day after Thanksgiving Day. There are a few special rules that apply to stock market holidays. When any of the above listed holidays falls on a Saturday, the market will be closed on the previous day (Friday) unless that Friday is the end of a monthly or yearly accounting period. If the holiday falls on a Sunday, the market will be closed the next day (Monday). The federal holidays the market is open on are Columbus Day & Veterans Day, and the market holiday the government is open on is Good Friday.

In my next post I will continue the topic of IRA’S and explain how SIMPLE’s work and how similar and yet different they are from SEP’s.

Types of IRA’s: SEP Explained

SEP’s & SIMPLE’s are very similar in nature. Both IRA’s are designed for those who are self-employed and/or small business owners. It’s vital for small businesses to offer their employee’s retirement plans as they serve as an incentive for both employee recruitment and retention while potentially increasing productivity. Please keep in mind both IRA’s are associated with many more rules and regulations outside of the scope of this text. Please consultant your tax advisor before making any financial decisions. Below is a brief overview of how SEP’s work.

• SEP: Many people aren’t aware of how Simplified Employee Pensions (SEP) work and miss out on the opportunity to increase their retirement funds. In a SEP account, one can make 2 types of contributions, one as an employer (if applicable) and another as an employee. What does this mean? Well if you are the owner of a company, you are also an employee of the company, thus you can make a contribution to your SEP as an employee and another as an employer. This allows you to save for retirement at a much faster pace! However, as there are contribution limits for Traditional & Roth IRA’s, the same goes for SEP’s. With a SEP, as an employee, there is a contribution limit of $5k a year. As an employer, the limit is 25% of total income, up to $49k. SEP’s allow small business owners to provide their employees with a retirement plan, while also benefiting from a tax deduction for contributions made to their employee’s accounts. Thus contributions can be made by the employer and/or the employee. Another great benefit for employees is that all contributions are immediately 100% vested, meaning there aren’t any time constraints, such as being an employee for a set amount of years.

Types of IRA’s: Roth Explained

• Roth: unlike Traditional, uses after-tax dollars. This means you can deposit money that you have already paid taxes on; however, these contributions cannot be deducted from your income unlike Traditional contributions. The purpose of a Roth is to have any realized gains grow tax free. So if you experience exponential gains in your portfolio, and you realize those gains, you can essentially distribute those funds tax free! However, there are 2 catches to enjoy this great benefit, and both must apply. For one, you have to have the Roth open for at least 5 years. This shouldn’t be a problem; after all, retirement is decades away for most people. Secondly and more importantly, you can begin distributing funds at the age of 59 ½ or later, and unlike a Traditional, there aren’t any RMD’s, so you can take your retirement money out at your own discretion.

Traditional & Roth Contribution Limits: anyone can contribute to their own IRA so long as they have earned income. It’s important to note contributions cannot exceed one’s income. For both Traditional & Roth IRA’s, one can deposit up to $5k a year if under 50 years of age, and $6k a year if over 50. However, for a Traditional, contributions can no longer be made after 70 ½. As for a Roth, income cannot exceed a set amount required by the IRS; otherwise it will have to be converted into a Traditional as they have no income limits. Catch-Up contributions can also be made (max $1k) for both IRA’s if the maximum allowed into your IRA for the previous year was never met. Spousal contributions are also allowed, but they must meet certain requirements set by the IRS.

Types of IRA’s: Traditional Explained

Traditional & Roth IRA’s are the most common and easiest to understand, therefore I will be focusing most of my explanation on differentiating the two. However, both IRA’s are associated with many more rules and regulations outside of the scope of this text. Please consult your tax advisor before making any financial decisions.

• Traditional: is the most commonly used IRA. It’s different in many ways from its Roth counterpart. The most notable difference is the pre-taxed dollars that go into it. That’s right, money deposited into Traditional IRA’s are tax free. Many enjoy this benefit and therefore deduct their contributions from their income when filing their taxes. However there is a catch. Any distributions made out of the account are subject to be taxed. Additionally, when you reach 79 ½ years old (no I don’t know why the half) you are obligated to make a Required Minimum Distribution (RMD). If an RMD is not made or only partially made, the RMD balance not distributed will incur a 50% penalty fee. You are, however, allowed to make distributions when you reach 59 ½, with any realized gains taxed at your regular federal income tax rate. Any distributions made before that age are subject to an additional 10% penalty fee on the amount distributed unless these funds are used to pay for qualifying medical expenses, college tuition, and up to $10k toward the purchase of a first home for yourself, your child, or your parents.

Types of Accounts: Tax Deferred (IRA's)

• Tax Deferred Accounts: these types of accounts are typically Individual Retirement Accounts (IRA’s); however there are other retirement and non-retirement accounts that can be tax deferred. We will get into those types of accounts later, for now let’s stick to IRA’s. There are several different types of IRA’s to choose from. Most brokerage firms offer Traditional, Roth, Rollover, SEP, and the newest a SIMPLE IRA. Every time a deposit is made into an IRA it’s considered a contribution, similarly when a withdrawal is made it’s considered a distribution. IRA’s have annual limits as to how much one can contribute. These limits are set by the IRS and are based on ones income. It’s important to note that although IRA’s are tax deferred, it does not suggest they are tax free. This simply means the gains realized in the account aren’t taxed immediately, instead they are taxed when a distribution is made, hence the term “deferred”. How does one know which IRA to choose? Like choosing a broker, there are several factors to take into consideration. First, let’s take a look at these different types of IRA’s so we can get a better understanding of how they work and which will be most beneficial for your investment objectives.