Several years ago, anticipating the burgeoning elderly population and to encourage people to create their own pension funds, Congress created the Investment Retirement Account (“IRA”) and a similar plan popularly called the “401(k) plan”; subsequently these were followed by a plan which has been designated the Roth-IRA. Both the traditional IRA’s and 401(k)’s have been attractive inducements for all of us to consider and act upon retirement plans.
In the traditional IRA’s and 401(k)’s the contributions reduce, dollar-for-dollar, a person’s taxable income in the year the contributions are made; in addition, income generated within these accounts is tax-free. However, when the funds are withdrawn (after a person reaches age 59), they are taxable as ordinary income.
The fundamental difference between the traditional IRA and 401(k) plans and the Roth-IRA plan is that in the Roth-plan, the contributions have no effect on the income of the taxpayer in the year they are made (i.e., they are made from after-tax income). Like the traditional plans, any income generated within a Roth-plan is tax-free; but, most important, whatever funds are withdrawn after age 59 from the Roth plans are not taxable.
Beginning in 2006, another retirement account, the Roth-401(k) plan, will be available. It is similar to the Roth-IRA, but there are fundamental differences between the plans. Where the Roth-IRA is available only to people earning less than $110,000 if filing singly and $160,000 if filing jointly, there are no income limits for those who contribute to Roth-401(k)’s. Additionally, while the contributions to both traditional and Roth-IRA’s are limited to $4,000 per year, the limit on traditional and Roth- 401(k)’s will be substantially greater, $15,000. (For people who will be at least 50 years of age by the end of the year, the limits will be $5,000 and $15,000, respectively.)
Roth-401(k) plans, like traditional 401(k) plans must be created formally by the taxpayer’s employers (not so with IRA’s, traditional or Roth), and the annual contribution limit applies to the cumulative contributions to both; for example, a person who is age 50 and contributes $12,500 to a traditional 401(k) would be limited to an $7,500 contribution to a Roth-401(k).
What Congress has done is to give each of us a number of options to encourage us to anticipate retirement. Take a long look at your retirement plans, sharpen your pencil, and take advantage of the plan which best fits your needs. In this article we have touched on the salient features; there are other limitations and conditions to be considered in all of these plans.
— Ken Butera