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401(k) IRA matrix

401(k) IRA matrix

From Wikipedia, the free encyclopedia

 

This is a comparison between 401(k), Roth 401(k), and Traditional Individual Retirement Account and Roth Individual Retirement Account accounts.

 

Comparison[1][2][3]

Tax Year 2008 401(k) Roth 401(k) Traditional IRA Roth IRA
Tax Implications Contributions are deposited as "tax deferred" and then taxed at normal income bracket for distributions Contributions are post tax money and no taxes have to be paid under normal distributions Contributed money is at first post tax money. However, contributions are tax deductible which reduce your tax basis for that tax year. Then, distributions are taxed at the normal income for distributions. Tax deductibility and participation in pension plans or 401k plans is limited Contributions are post tax money and no taxes have to be paid under normal distributions
Income Limits Generally none, but somewhat complicated due to HCE (highly compensated employees) rules Single, HoH, MFS: full contrib to $53k, partial to $63k; MFJ; QW: full contrib to $85k, partial to $105k; can't contribute more than you make in that year Single: full contrib up to $101k, partial contrib to $116k; Married: full contrib up to $159k, partial contrib to $169k; can't contribute more than you make in that year
Contribution Limits $16.5k/yr for under 50, $22k/yr for 50 and over in 2009; limits are a total of trad 401(k) and Roth 401(k) contributions. Employee and employer combined contributions must be lesser of 100% of employee's salary or $46k. $5k/yr for age 49 or below; $6k/yr for age 50 or above in 2009; limits are total for trad IRA and Roth IRA contributions combined
Employer or Individual Employer sets up this plan Individual sets up this plan
Matching Contributions Matching contributions available from employers. Matching contributions available through employers, but they must sit in a pretax account No matching contributions available
Distributions Distributions can begin at age 59 1/2 or if owner becomes disabled Distributions can begin at age 59 1/2 and the account has been open for at least 5 years; there are exceptions though; or if owner becomes disabled Distributions can begin at age 59 1/2 or if owner becomes disabled Distributions can begin at age 59 1/2 as long as contributions are "seasoned" (been in the account for at least 5 years) or owner becomes disabled
Forced Distributions Must start withdrawing funds at age 70 1/2 unless employee is still employed. Penalty is 50% of minimum distribution. Must start withdrawing funds at age 70 1/2 unless employee is still employed and not a 5% owner. Penalty is 50% of minimum distribution. Must start withdrawing funds at age 70 1/2. Penalty is 50% of minimum distribution. None
Contribution Withdrawal No, but loans from this plan are available depending upon employer's plan Yes, as long as the account has been open for more than 5 years, however the proportion of withdrawal equal to the proportion of profits to contributions in the account is subject to 10% penalty plus taxes No At any point, the owner may withdraw the total contributed into the IRA
Early Withdrawal 10% penalty plus taxes including withdrawal for hardships Proportion of withdrawal equal to the proportion of profits to contributions in the account is subject to 10% penalty plus taxes including withdrawal for hardships 10% penalty plus taxes for distributions before age 59 1/2 with exceptions Early withdrawal that is more than contributions plus seasoned conversions are subject to normal income taxes and 10% penalty if not qualified distributions
Home Down Payment Purchase of primary residence and avoidance of foreclosure or eviction of primary residence is subject to 10% penalty. none Can withdraw up to $10k for a first time home purchase down payment with stipulations Up to $10k can be used for primary home down payment. Must not have owned a home in previous 24 months. House must be owned by IRA owner or direct linear ancestors or descendants.
Education Expenses Payment of secondary educational expenses in last 12 months for employee, spouse, or dependents subject to 10% penalty Can withdraw for qualified higher education expenses of owner, children, and grandchildren
Medical Expenses Medical expenses not covered by insurance for employee, spouse, or dependents subject to 10% penalty Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability
Conversions Upon termination of employment, can be rolled to IRA or Roth IRA. When rolled to a Roth IRA taxes need to be paid during the year of the conversion. Cannot be converted to a trad 401(k), but upon termination of employment, can be rolled into Roth IRA Can be converted to a Roth IRA. Taxes need to be paid during the year of the conversion. Other limitations though.  
Changing Institutions Can roll over to another employer's 401(k) plan or to a traditional IRA at an independent institution. Can roll over to another employer's Roth 401(k) plan or to a Roth IRA at an independent institution. Funds can be transferred to another institution or they can be sent to the owner of the trad IRA who has 60 days to put the money in another institution in a rollover contribution to another traditional IRA[4] Funds can be transferred to another institution or they can be sent to the owner of the Roth IRA who has 60 days to put the money in another institution in a rollover contribution to another Roth IRA[4]
Inside The Account Capital gains, dividends, and interest within account incur no tax liability
Beneficiaries   When owner dies, spouse as beneficiary can roll both accounts into one IRA account. Other beneficiaries will be subject to forced distributions (taxable) based on life expectancy. Beneficiaries will not pay estate tax if the inheritance is under the exemption amount. When owner dies, spouse as beneficiary can roll both accounts into one Roth IRA account. Other beneficiaries will be subject to forced distributions (tax free) based on life expectancy. Beneficiaries will not pay estate tax if the inheritance is under the exemption amount.
Other   Slowly growing in popularity after its recent creation [5]  

 

IRA: Roth vs. Traditional

The decision between choosing a Roth IRA vs. a Traditional IRA depends mostly on whether you are likely to be in a higher tax bracket in the future (in which case a Roth IRA is better) or a lower tax bracket in the future (in which case a conventional IRA is better). Roth IRAs also have a bit more flexibility in terms of early withdrawal. If your tax bracket does not change while you are working vs. when you retire, you will end up with the same amount of money in a Roth IRA as a conventional IRA for a donation less than the maximum allowable. If you save the maximum allowable amount in an IRA, and you stay in the same tax bracket, there is a tax advantage to the Roth-IRA. For instance, in 2007 the maximum traditional IRA for a 40 year old was $4000. Any additional investment above that would have to go into a different account. The following example illustrates the tax consequences:

Roth IRA. A $4000 contribution to a Roth-IRA growing at a constant rate of 10% will, in 25 years, grow to 4000 * 1.125 = $43,338.82. Because this $4000 contribution is not tax-deductible, the contribution plus the tax will cost 4000 / (1-.25) = $5333.33 in the year of contribution (i.e. the taxes on $5333.33 earned will be $1333.33, leaving $4000 to invest).
Traditional IRA. $4000 contributions to traditional IRA will grow to $43,338.82 in 25 years using the same assumptions and calculations above. The tax on this amount will be 25% * 43,338.82 = $10,834.71, leaving 43,338.82 - 10,834.71 = $32,504.12 from the IRA account. However, the investor will have additional tax savings of 4000 * 0.25 = $1000.00 to invest in a "naked" (i.e. taxable) account. (Equivalently, out of earned amount of 5333.33, 4000 will go towards IRA contribution, and remaining 1333.33 will be taxed at 25% with $1000.00 left to invest.) With earnings taxed every year, this $1000 amount will grow to 1000 * (1 + .1 * [1-.25])25 = $6,098.34. This implies a total, after-tax amount of 32,504.12 + 6,098.34 = $38,602.46 (roughly 12% worse than Roth IRA with our assumptions).
Explanation. The Roth IRA is better because we are effectively making use of $5333.33 for Roth IRA tax advantages but are only able to use $4000 for Traditional IRA tax advantages.
If total $5333.33 amount were able to grow in a tax-deferred Traditional IRA account, then the additional $1333.33 would grow to 1333.33 * 1.125 = $14,446.27, and if taxed at 25% upon withdrawal would imply 14,446.27 * .25 = $3611.57 in taxes, leaving 14,446.27 - 3611.57 = $10,834.71. Adding this to the $32,504.12 amount from the Traditional IRA savings equals 32,504.12 + 10,834.71 = $43,338.82, just like in the Roth IRA.

Note that the same applies to choosing whether to contribute the same amount to regular or Roth 401(k) - either because you only want to contribute up to the employer match, or because you want to contribute up to the maximum amount. If, on the other hand, you are able and willing to contribute extra tax savings to Traditional IRA / 401(k), tax advantages of Roth IRA / 401(k) over Traditional IRA / 401(k) highlighted above will no longer apply.

 

References

  1. ^ IRS Publication 4530 [1]
  2. ^ IRS Retirement Article [2]
  3. ^ IRS Roth Chart [3]
  4. ^ a b "Publication 590". Internal Revenue Service. Retrieved on 2007-04-18.

 

 

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