Individual Retirement Plans are becoming more and more popular as companies are cutting back on pension plans for employees. There are several different types of individual retirement plans available to choose from, with each offering their own respective benefits. Some of the different retirement plans available include the following: Individual Retirement Accounts (IRAs), 401(k) plans, and Keogh plans.
Individual Retirement Accounts are retirement plans set up strictly by an individual at his/her own will. IRAs allow a person’s earnings to compound on a tax deferred basis. When looking at IRAs, there are two types, the Traditional IRA and the Roth IRA, each having their own unique features. Traditional IRAs allow the investor to make contributions on a pre tax basis, but there are limitations on this feature. For example, many public sector employees are not eligible to make fully deductible contributions. Also, if you have an employer funded retirement plan you may not be able to make fully deductible contributions if your modified adjusted gross income is over a certain number (For 2008: $53,000 for single filers/$85,000 joint filers) (source 1). In Roth IRAs, the investor contributes to the plan with income that has already been taxed, however the withdrawal of funds is tax exempt (provided the individual is at least 59 ½ years old and other conditions are met). A drawback to Roth IRAs is that in order to make the full $5,000 annual contribution to the fund, the individual must have a modified adjusted gross income of below $101,000 (for 2008) (source 1). Another difference between the two types of IRAs is that with Roth IRAs, one can continue to contribute to the fund after the age of 70 ½ , which is not allowed with a Traditional IRA. As mentioned, there are several factors one has to take into account when deciding whether to go with a Traditional or Roth IRA.
Another popular individual retirement plan is the 401(k) plan. The 401(k)’s namesake comes from the section of the US tax code from which it was derived. 401(k) plans allow employees to contribute a certain portion of their salary to the plan on a tax free basis; employers may also choose to match employee contributions. Along with the ability to contribute money on a tax free basis, there are other advantages to having a 401(k). One advantage is that all employer contributions are allowed to grow tax free until withdrawal. Another advantage of a 401(k) is that if an employee decides to make a career move to a different company, all contributions can be moved to the new company’s plan.(source 2) As with IRAs, 401(k) plans do have contribution limits, as of 2008 the maximum employee pre-tax contribution limit was $15,500. However, this contribution limit does not include any employer contributions.
As with most things, there are a few disadvantages to 401(k) plans. One disadvantage is that it is difficult to take out any savings before the age of 59 ½ without penalty, although it is possible. Another disadvantage of 401(k) s is that employer contributions are not vested until at least 3 years after contribution. Also, for highly compensated employees (defined by the IRS as those making over $100,000 in...