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Retirement

  • 401(k) and IRA contribution
    A:

    If you contribute to your 401(k) account, you may still contribute to a Roth IRA and/or a traditional IRA.

    Your 401(k) contribution has no effect on your Roth IRA contributions. You only need to make sure you meet the eligibility requirements for funding a Roth IRA. (For more on this, see Roth IRA: Back To Basics.)

    However, your participation in the 401(k) plan may affect your ability to take a tax deduction for any traditional IRA contributions. It will not affect the amount you are able to contribute (up to an annual $5,500; $6,500 if you’re age 50 or older, for 2018).

    Factors to Consider

    Basically, if you are covered by 401(k) (or any employer-sponsored plan), your modified adjusted gross income (MAGI) becomes a factor in the deductibility of IRA deposits. For example, In 2018, single taxpayers/plan participants can't take an IRA deduction if their MAGI is $73,000 or over; those making between $63,000 and $73,000 could take a partial deduction. Those making under $63,000 or less can take a full deduction – regardless of their 401(k) participation.

    Publication 590-A from the IRS explains the deductibility of IRA contributions; it provides the formula you need to calculate how your 401(k) plan contributions affect your IRA contributions. If you are single, you only have to calculate your own contributions, but if you are married anf filing jointly, you must take into consideration your spouse’s employer plan participation and any deductible contributions your spouse makes to IRAs, too. Calculate your IRA contributions and your spouse’s contributions separately using the worksheet that is available on the IRS website.

    If you complete the worksheet and discover that some or all of your IRA contributions are nondeductible, you may want to take out the amount you overcontributed. There is no additional tax or penalty to remove the excess contribution as long as you do so before you file your taxes for the year in which the contribution was made.

    Although you do not pay income tax on the removal of the principal amount of the contribution, you may encounter a gain on your account attributable to the contribution, in which case you also need to remove that amount. Any gain or income you made on the contribution also needs to be added to your gross income for the year and may be subject to a 10% early withdrawal penalty if you are under 59½. For these reasons, it is wise to determine your eligibility for IRA contributions before you make them.

    In short, depending on your income, contributing to a 401(k) can limit your ability to contribute to an individual retirement account. If you are what is called an “active participant” in an employer-sponsored plan, or your spouse is, you need to follow a formula to determine whether you can make deductible IRA contributions. To learn more, see Are You an Active Participant? and Traditional IRA Deductibility Limits.


  • 401(k) vs. Roth IRA
    A:

    The major differences between a 401(k) and a Roth IRA, which are both popular tax-advantaged retirement savings vehicles – are tax treatment, investment options, and possible employer contributions. It is possible to contribute to both plans, but not with the same dollars.

    401(k) Plan

    Named after section 401(k) of the Internal Revenue Code, a 401(k) is an employer-sponsored deferred-income plan. To contribute to a 401(k), the employee designates a portion of each paycheck to be diverted into the plan. These contributions occur before income taxes are deducted from the paycheck.

    The investment options among different 401(k) plans can vary tremendously, depending on the plan provider. But no matter which the fund (or funds) the employee chooses for his money, any investment gains realized within the plan are not taxed by the IRS. Taxation only occurs after the employee has reached retirement age and begins to make withdrawals from the plan. These distributions, as they're known, are subject to income taxes, at the retiree's current tax rate.

    As of 2018, the limit for annual 401(k) contributions is $18,500 for those under the age of 50. Those ages 50 and older can contribute an additional $6,000 per year.

    To be sure, 401(k) plans are most beneficial when an employer offers a match, contributing additional money to the employee's 401(k) account – usually a percentage of the employee's contribution. This is a form of additional deferred income; it doesn't directly affect the employee's contribution, but overall, 401(k) contributions from all sources can't exceed $55,000 annually (or $61,000 for employees over age 50). 

    Roth IRA

    A variation of traditional individual retirement accounts (IRAs), a Roth IRA is set up directly between an individual and an investment firm; the individual's employer is not involved. As there is no employer, there is no opportunity for an employer match with Roth IRAs. Since the account is set up and controlled by the account owner, investment choices are not limited to what is made available by a plan provider. This gives IRA accounts a greater degree of investment freedom than employees have with 401(k) plans.

    In contrast to the 401(k), after-tax money is used to fund a Roth IRA. As a result, no income taxes are levied on withdrawals during retirement. While in the account, any investment gains are untaxed.

    The contribution limits are much smaller with Roth IRA accounts. In 2018, the maximum annual contribution is $5,500 for those under the age of 50, while those ages 50 and up can contribute an additional $1,000 for a total of $6,500 per year. Individuals who earn more than $135,000 per year (or $199,000 for couples) are ineligible to contribute.

    Roth accounts make the most sense for individuals who believe that they will be in a higher income tax bracket when they retire than they are in currently. Obviously, it's better to pay taxes on a smaller percentage on your income prior to contributing (as in a Roth IRA) than to pay a larger percentage of taxes on withdrawals (as in a 401(k) or traditional IRA ).


  • A lot of retirement projections seem to assume an 8% rate of return. Is this realistic?
    A:

    Many financial advisors would feel that an 8% rate of return is too high, and are more likely to work with 4-5% estimated return, depending on the dollar amount that is assumed will be invested.

    The 8% (or more) rate of return became the norm for financial advisors when doing projections during the 1990s and 2000s because the portfolios that they managed were producing 8% returns, and in some cases, even higher returns. By 2008, however, things had begun to change as advisors became less optimistic about the likelihood that these high returns would be possible going forward on a consistant basis.

    Unfortunately, Investopedia does not know of a nice safe place for one's nest egg that pays 8%, and it is unlikely that anyone else does either. That said, take financial articles for what they are worth: general education to increase awareness. If you are looking for projections that apply to you, visit a professional. Your best bet would be to contact a financial planner and create a plan that best suits your needs for today and your golden years. (For more on retirement planning, check out our Retirement Planning Tutorial.)


  • Annuities: Present Value Versus Future Value
    A:

    The present value of an annuity represents the sum that must be invested now to guarantee a desired payment in the future, while the future value of an annuity is the amount to which current investments will grow over time.

    What Is an Annuity?

    Though often associated with a specific insurance-related product, an annuity is any asset that generates regular payments for a set time period. This type of investment is often used by those preparing for retirement or for a period of planned unemployment. Depending on the types of investments used, annuities may generate either fixed or variable returns.

    Both the present and future value calculations assume a regular annuity with a fixed growth rate. Many online calculators determine both the present and future value of an annuity, given the interest rate, payment amount and duration.

    Present Value of an Annuity

    The present value of an annuity is simply the current value of all the income generated by that investment in the future – or, in more practical terms, the amount of money that would need to be invested today to generate consistent income down the road. Using the interest rate, desired payment amount and number of payments, the present value calculation discounts the value of future payments to determine the contribution necessary to achieve and maintain fixed payments for a set time period.

    For example, the present-value formula would be used to determine how much to invest now if you want to guarantee monthly payments of $1,000 for the next 10 years.

    Future Value of an Annuity

    The future value of an annuity represents the amount of money that will be accrued by making consistent investments over a set period, assuming compound interest. Rather than planning for a guaranteed amount of income in the future by calculating how much must be invested now, this formula estimates the growth of savings, given a fixed rate of investment for a given amount of time.

    The future-value calculation would be used to estimate the balance of an investment account, including interest growth, after making monthly $1,000 contributions for 10 years.

    See also For what types of financial instruments would I want to calculate the present value of an annuity?

     

  • Are 401(k) contributions tax deductible?
    A:

    All contributions to qualified retirement plans such as 401(k)s reduce taxable income, which lowers the total taxes owed. For 2018, the annual limit is $18,500, except for people who are 50 or older. They can contribute an additional $6,000 per year, as long as they turn 50 in that calendar year. About 97% of 401(k) plans allows such catch-up contributions. Whether regular or catch-up, the contribution is fully tax-deductible.

    Understanding 401(k) Contributions

    Whether regular or catch-up, the 401(k) contribution is taken right off the top of the income for the year, making it more advantageous if you are in a higher tax bracket. For example, suppose a single person earning $55,000 a year has a 401(k) plan and starts setting aside $5,000 a year. At $55,000, he is in the 22% federal tax bracket in 2018. Since the 401(k) contribution is fully deductible, his taxable income for the year drops to $50,000, saving him $1,100 per year.

    Meanwhile, a single high-income earner making $201,000 is in the 35% tax bracket (which starts at $200,001). If he starts contributing the maximum amount, $18,500 per year, he drops a full bracket and end up being taxed in the 32% bracket.

    Distributions From a 401(k)

    There are two reasons why making the contribution, and getting the tax deduction is worthwhile during your working years.

    First of all, there's more capital working on your behalf during the years leading up to retirement. A person in the 24% tax bracket with 20 years until he quits can either save a pretax $400 a month in a 401(k) plan or get a post-tax $300 and put it in a regular brokerage account. The extra $100 per month from the first option quickly increases the size of the nest egg, adding the power of compounding over 20 years. It could be tens of thousands extra by the time he bids the work world good-bye.

    Second, the distributions (withdrawn funds) from the 401(k) are taxed as regular income. But presumably, you're withdrawing them during retirement. Retirees typically have lower income than they did when they were working. A married couple in the 35% bracket may drop to the 24% bracket once they've retired. They made their deductions to the tune of 35%, but they only pay 24% when collecting their monthly payouts, earning them an extra 11% right off the top.


  • Are 401(k) withdrawals considered income?
    A:

    All 401(k) plan withdrawals are considered income and subject to income tax, including capital gains. When you take a premature distribution – a withdrawal before age 59½ from a 401(k), IRA or any other tax-deferred retirement account or annuity – that withdrawal is also subject to an extra 10% penalty tax from the Internal Revenue Service (IRS).

    When a 401(k) Loan Becomes a Taxable 401(k) Withdrawal

    Some 401(k) plans let you take out loans from up to 50% of your available account balance. If you cannot pay back the full balance of the loan within five years, then it is considered to be a withdrawal and is subject to income tax. If you are under age 59½ at that time, then that early distribution is also subject to the 10% penalty fee.

    Another instance in which a 401(k) loan becomes a taxable 401(k) withdrawal is if you cannot pay back the remaining balance of the loan upon termination of employment.

    Exceptions to the Extra 10% Penalty Tax

    While all 401(k) distributions are subject to income tax, there are several exceptions to the extra 10% penalty tax. One is if you roll over the funds into another qualified retirement plan (see Are 401(k) rollovers taxable?).

    Another concerns health-related costs. If the amount of your unreimbursed medical expenses is more than 10% of your adjusted gross income (AGI) (7.5% if you are 65 or older) and you take a distribution from your 401(k) to cover those expenses, then the IRS exempts you.

    When you take a loan from your 401(k), you might open a separate checking account to deposit the withdrawal and make the medical payments. By keeping a detailed paper trail of the use of your 401(k) funds, you can be ready in case of an audit.


  • Are 401ks FDIC insured?
    A:

    The Federal Deposit Insurance Corporation (FDIC) works as a protector for customers when banks and financial institutions fail. The total limit per person is $250,000, and it is applicable to checking accounts, savings accounts and certificates of deposit (CDs). Mutual funds, stocks, bonds, annuities, Treasury securities and similar products are not covered by FDIC protection.

    As a result, 401(k) accounts are generally not covered, since the assets invested are typically found in the list of exclusions. The one exception is money that is sitting in money market deposit accounts. This is usually the landing zone for fresh money being deposited into the account, giving little or no interest. As soon as that money is moved into funds or stocks, the FDIC coverage disappears. If you have $100,000 in your 401(k) with $20,000 in a money market deposit account and $80,000 in stock and bond funds, you have FDIC coverage for $20,000 if the company folds.

    Most U.S. brokerage companies are also covered by insurance by the Securities Investor Protection Corporation (SIPC). The SIPC protects customers in the event a company folds, returning cash, stocks and other securities up to $500,000.

    If money exceeds the FDIC coverage, it isn't lost, but you have to wait in line with other creditors while the company's assets are liquidated. You are unlikely to receive full, dollar-for-dollar compensation for money that exceeded the FDIC coverage. That's why it can make sense for high-value investors to divide assets between different banks or brokerages during uncertain times.


  • Are catch-up contributions allowed for SEP IRAs?
    A:

    In general, catch-up contributions are not allowed for SEP IRAs because these plans require contributions to be made by employers only. Since catch-up contributions are made by the account-owning employee, they are not permitted.

    However, some SEP plans may allow employees to make traditional IRA contributions, not salary deferrals, to the account rather than opening another IRA. In this case, employees can make their own contributions to the account, including catch-up contributions if allowable, up to the normal IRA contribution limit.

    What Is an SEP IRA?

    An SEP, or simplified employee pension, is a type of qualified retirement savings plan offered by employers for employees who meet certain age and employment criteria. Rather than each employee owning an account in a company-sponsored plan, such as a 401(k), each employee participating in SEP has her own individual retirement account (IRA). The employer then has the sole responsibility for making contributions to each employee's IRA.

    Like other retirement plans, the IRS imposes strict regulations regarding acceptable contribution limits. In 2015 and 2016, SEP contributions to each employee's account cannot exceed 25% of employee compensation, or $53,000, whichever is less.

    Catch-Up Contributions

    Under the terms of more common retirement savings plans, which provide for contributions by the account owner herself, the IRS allows plan participants over the age of 50 to make annual catch-up contributions to bulk up savings in the years leading up to retirement. For 2015 and 2016, the annual catch-up contribution limits for 401(k), 403(b) and SARSEP plans is $6,000. For self-directed IRAs, the limit is $1,000.

    Exception to the Rule

    Both the sponsoring employer and the financial institution administrating an SEP IRA have an impact on the specific terms of the plan. Some plans provide the option of making individual contributions to an SEP IRA. In this case, your contributions are not salary deferrals and have no impact on the amount your employer contributes. Instead, you can contribute to your SEP IRA at your discretion as frequently or infrequently as you choose, just as you would to a self-directed account.

    If your SEP IRA provides this option, then your individual contributions are subject to the same limitations as any other traditional or Roth IRA. If you are over 50, you are eligible to make the maximum annual contribution of $6,500, which includes the additional $1,000 allowable catch-up payment.


  • Are dividends the best way to make money for retirement?
    A:

    There are numerous theories that speak to the best method to save for retirement – a traditional asset allocation based time frame, inclusion of alternative asset classes to achieve broader reach and the consideration of dividends as a means to hedge against market risks. Here, we consider the advantages and disadvantages of utilizing dividends when saving for retirement.

    Understanding Dividends

    Before determining whether dividends are the best option for retirement savings, it is important to understand how dividends work. When an investor purchases a stock, he or she becomes a proportional owner of the company based on how many shares of stock are purchased. Because of this relationship, profit achieved by the company is shared with the shareholder in one of two ways:

    • A dividend is paid out on a per-share basis. If an investor owns 100 shares, and the company declares a 50-cents-per-share dividend, the investor receives a total dividend payout of $50.

    • The company’s stock price may increase over time, making the shares owned by the investor more valuable.

    Dividends are typically paid in cash on a quarterly basis and must be owned by the ex-dividend date in order to receive the declared dividend. Shareholders who own preferred stocks receive fixed-rate dividends, while common stock shareholders receive variable-rate payouts.

    Advantages of Dividends

    Most investors are concerned with poor investment performance, loss of principal and the constant threat of high inflation. Dividends can provide a hedge against these risks while saving for retirement. According to Bloomberg, more than 40% of large capitalization stocks' return since 1931 has consisted of dividends, creating a positive argument for the use of dividend-paying stocks within an investor's long-term portfolio.

    Although equity investments are attractive to investors for the potential of higher returns, volatility within the market can be a cause for concern for investors saving for retirement. Focusing solely on capital appreciation through equity investment may not provide the consistency investors need in order to achieve retirement savings goals. Adding dividend-paying stocks in an allocation can help mitigate loss in equity positions.

    Investors can use dividends to hedge against rising inflation for the long term. Although rates have been relatively low recently, inflation still has a corrosive effect on investment returns. Investors who hold positions in dividend-paying stocks may be better able to navigate higher inflation rates while saving for retirement.

    Disadvantages of Dividends

    Although there are reasons why investors may want to supplement capital appreciation in equity positions with seemingly steady dividend payments, there are caveats to consider. Dividends are not guaranteed; reliance on consistent payouts could skew savings projections in the wrong direction. Should companies decide to not declare dividends, investors could fall short of their savings goals.

    Dividends are taxed at a qualified dividends tax rate which depends on the income bracket that the investor falls into, while the gains associated with the sale of appreciated stock are taxed at the lower capital gains rate. Paying higher taxes can have a detrimental effect when the time comes to take income in retirement.

    Although dividends can present an opportunity for consistent growth and a hedge against inflation, investors saving for retirement need to be aware of the potential drawbacks to this investment strategy.


  • Are estate planning fees tax deductible?
    A:

    Estate planning fees may be tax deductible, but only if certain conditions have been met.

    Internal Revenue Service (IRS) Rules

    In order to be deductible, the IRS requires that estate planning fees must be paid: (1) for the production or collection of income; (2) for the management, conservation or maintenance of property held for the production of income; or (3) in connection with the determination, collection or refund of any tax.

    So how might this apply to estate planning fees? If, for example, the estate plan involves advice on the construction of income generating instruments, such as an income trust, or provides guidance on the use of property transfer methods to avoid Federal or State Estate or Inheritance tax, these would meet the IRS restrictions for the ability to deduct such expenses. Other examples might include investment advice for trusts held by the estate, trust tax preparation fees and account custodial fees while held by the estate.

    However, the billing invoice from the legal or accounting authority providing this advice would have to clearly identify these expenses as being for the current or future production of income or payment of current or future tax. Estate planning relating to the simple transfer of property or guardianship as is common with most wills, or the use of estate planning instruments such as powers of attorney, living wills or the writing of trusts to prevent estate assets from being encumbered in probate, would be deemed personal expenses that would not be deductible.

    Itemized Deductions

    Estate planning fee deductions must be taken as miscellaneous itemized deductions that will be subject to the 2% of adjusted gross income (AGI) floor. For example: if the total of all such allowable estate planning fees is $3,000 and the taxpayer's AGI is $100,000, then 2% of this AGI would be $2,000; therefore $3,000 - $2,000 = $1,000 would be deductible.


  • Are mutual funds considered retirement accounts?
    A:

    Unlike a 401(k) or Individual Retirement Account (IRA), mutual funds are not classified as retirement accounts. Employers generally do not sponsor them like a 401(k), and the Internal Revenue Service (IRS) does not offer the tax benefits on mutual fund accounts that it does for 401(k) plans or IRAs. Earnings from qualified retirement plans are not subject to taxation until a person withdraws money from the account.

    With that said, investing directly in mutual funds can be an effective way to save for retirement. In fact, many 401(k) plans offer the option to have some or all of the money invested put into mutual funds.

    Mutual Funds Explained

    A mutual fund is a pool of hundreds or even thousands of stocks, bonds and other asset classes. While it is subjected to the same market whims as individual investments, its inherent diversification makes it safer and less volatile. Investing in individual stocks poses extra risk because the investor's money is tied up in a single company. Failure of that company often means financial ruin for those invested heavily in it. By contrast, the failure of a single company has a far less dire effect on investors who are only exposed to it as part of a mutual fund, since their money is spread across hundreds of companies.

    How Mutual Funds Fit Into Retirement Plans

    Retirement plans, such as 401(k)s, allow savers some degree of control over how their money is invested. Investors get to choose between mutual funds, index funds and other types of investments.

    Mutual funds are a popular choice for 401(k) holders who have autonomy over how their retirement savings are invested. The main drawback for using a 401(k) to invest in mutual funds is most retirement plans have a limited number of funds from which to choose, often 20 or fewer.

    While not classified as retirement accounts, mutual funds can offer an effective and relatively safe way to accumulate long-term wealth for retirement.


  • Are My Social Security disability benefits taxable?
    A:

    Social Security disability benefits may be taxable if you receive other income that places you above a certain threshold. The majority of Social Security disability recipients, however, do not have to pay taxes on that income. The reason is that most people on disability have little to no other income.

    How Social Security Disability Works

    President Franklin Roosevelt created the Social Security program as part of his New Deal government reform of the 1930s. The purpose of the New Deal was to help lift the country out of the Great Depression and provide a social safety net for elderly citizens and those with disabilities that prevented them from making a normal living.

    The majority of Social Security recipients fall into the former category. They have reached retirement age, where the minimum age to collect benefits is 62, and receive a monthly Social Security check based on the amount they paid into the program during their working years.

    Social Security disability recipients do not have to be a certain age to receive benefits. Instead, their disability must meet certain criteria established by the Social Security Administration, or SSA. The condition must be severe. It must prevent a person from doing the work he did previously, and it must be determined, based on age, education, experience, and other factors, that the person would have difficulty training for a new career.

    Additionally, the recipient must presently not be working, or working so little his monthly income is under $1,090. The specific type of disability must be included on the SSA's approved list or otherwise judged to be of equal severity to a condition on the list.

    When Disability Benefits Are Taxed

    Whether disability benefits are taxed depends on your total income. To avoid taxation, your total income — determined by adding one-half of your disability benefits to all other sources of income including tax-exempt interest — must fall below the threshold set by the SSA.

    If you are single, the threshold amount is $25,000. If you are married and file jointly, it is $32,000. If you are married and live with your spouse but file separately, the threshold is $0, meaning at least some of your benefits are taxable.

    State Taxes on Disability Benefits

    Most states do not tax Social Security benefits, including those for disability. As of 2015, however, a total of 13 states still tax benefits to some degree. These states are Minnesota, Montana, Missouri, Nebraska, Colorado, Connecticut, Kansas, Utah, Vermont, West Virginia, New Mexico, North Dakota and Rhode Island. Most of these states use similar income criteria to the ones used by the SSA to determine how much, if any, of your disability benefits are taxable.


  • Are Roth 401(k) plans matched by employers?
    A:

    Roth 401(k) plans are typically matched by employers at the same rate as they match traditional 401(k) plans. Some employers do not offer Roth 401(k) plans.

    A Roth 401(k) is an employer-sponsored investment account that is similar to a traditional 401(k) plan in almost every way, except that the contributions to the account are taxed up-front rather than at the time of withdrawal. In a traditional 401(k), you pay taxes at the time the funds are withdrawn, which means you pay taxes on both your initial investment and your investment returns. The Roth 401(k) prevents you from being taxed on your investment returns at the time of withdrawal, as long as the withdrawal happens after you are 59½ years old.

    If an employer matches a traditional 401(k) plan contribution, it is standard for it to match one for a Roth 401(k). Unlike the employee's contribution, however, the employer's contribution is placed into a traditional 401(k) plan, and it is taxable upon withdrawal. Many employers have found the additional administrative demands of offering the Roth 401(k) outweigh the benefits to their employees and therefore do not offer one. This is the reason for the perception that employers cannot provide a match to Roth 401(k) employee contributions, when in reality, they are simply not providing the option for the plan at all.

    It is important to note that a traditional 401(k) plan can be rolled into a Roth (401)k plan. Once funds from any source are in the Roth (401)k plan, they cannot be moved into a traditional 401(k) plan, however.


  • Are SIMPLE IRA plans subject to ERISA?
    A:

    Savings Incentive Match Plans for Employees, or SIMPLE IRAs, are employer-sponsored retirement plans that allow employees of small businesses to make contributions via salary deferrals. These plans are covered by the Employee Retirement Investment Security Act, or ERISA, which details requirements for structure and administration of employer retirement plans.

    For SIMPLE IRAs, ERISA dictates which employees are eligible and how a company is to handle employee contributions. Employers must clearly detail the plan's features within a Summary Plan Description. In this document, vesting schedules and an explanation of employees' rights and employer responsibilities are established. ERISA allows employers some flexibility to tailor the eligibility requirements, but generally, all employees over the age of 21 who have worked at least one year of service must be eligible for the plan. Some employers may allow employees to become eligible sooner, sometimes even immediately.

    ERISA also defines key issues with regard to handling employee contributions. For example, salary deferral contributions for a SIMPLE IRA must be deposited in the participant's account by the end of the month following the month in which the funds were withheld from the participant's paycheck. Since these accounts are IRAs, the employee participant has full control over the investment choices for his or her SIMPLE IRA unlike a 401(k) plan, which has prescreened funds to review. With a SIMPLE IRA, the employer chooses and files the plan using IRS forms 5404 or 5405, designating a particular financial institution to hold all participants' accounts or allows participants to house their SIMPLE IRA at the financial institution of their choice.


  • Are Social Security benefits adjusted for inflation?
    A:

    Social Security benefits are adjusted for inflation. This adjustment is known as the cost of living adjustment (COLA). For the program's initial nearly four decades, benefit amounts did not increase based on higher living costs. The inflation of the 1970s, which was particularly hard on seniors with fixed incomes, prompted the Social Security Administration (SSA) to modify the program so inflation would trigger increases in benefit amounts.

    How the COLA Began

    The SSA enacted the cost of living adjustment in 1972. The removal of the dollar from the gold standard, rising oil prices, supply shocks and other factors had triggered unprecedented inflation that would plague the remainder of the decade. While workers received some relief from rising prices, since their wages also climbed, seniors on fixed incomes struggled badly. The COLA was a necessary addition to Social Security to ensure that beneficiaries with no other sources of income could still make a living.

    How the COLA Is Determined

    The COLA is based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This index measures what workers with modest incomes pay on average for retail goods. When the CPI-W increases by more than 0.1% from one year to the next, the SSA makes a COLA to the Social Security program accordingly. During years when the CPI-W increase is nominal or negative, Social Security recipients receive no COLA.

    On Jan. 1, 2015, recipients received a cost of living adjustment of 1.7% over their 2014 benefit amounts.


  • Are Social Security benefits taxable after age 62?
    A:

    Eligibility to collect Social Security benefits begins at age 62. Many seniors, to collect larger benefit amounts, wait until a later age. Whether Social Security benefits are taxable by the Internal Revenue Service (IRS) depends on how much additional income the person filing taxes receives. Some states, though not many, assess taxes on benefits.


    How to Determine If Social Security Benefits are Taxable

    A senior whose only source of income is Social Security does not have to pay federal income taxes on his benefits. If he receives other sources of income, including tax-exempt interest income, he must add one-half of his annual Social Security benefits to his other income and then compare the result to a threshold set by the IRS. If the total is more than the IRS threshold, some of his Social Security benefits are taxable.

    As of 2017, the threshold amount is $25,000 for singles and $32,000 for married couples filing jointly. Married couples who live together but file separately have a threshold of $0 and must pay taxes on Social Security benefits regardless of other income earned.

    States That Tax Social Security Benefits

    Most states do not tax Social Security benefits, but 13 do under certain circumstances. The states that tax Social Security benefits are Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia. Iowa used to assess taxes on benefits until it phased the taxes out completely in 2014, while New Mexico exempts some benefits for beneficiaries age 65 and over.


  • Are Social Security payments included in the US GDP calculation?
    A:

    Social Security payments are not included in the U.S. definition of the gross domestic product (GDP).

    Transfer Payments

    For the purposes of calculating GDP, government spending does not include transfer payments – the reallocation of money from one party to another – which includes Social Security, Medicare, unemployment insurance, welfare programs and subsidies. Because these are not payments for goods or services they do not represent a form of final demand, or GDP.

    However, once the recipient uses a transfer payment to purchase a good or service, it is captured in the personal consumption expenditure component of GDP. To include Social Security or other transfer payments and personal consumption in GDP would be a form of double-counting.

    Transfer payments are included in government current expenditures and total government expenditures, which are used for budgeting purposes.

    Calculating Gross Domestic Product

    The GDP measures the value of the production of goods and services, and it is the most common gauge of the overall size of an economy. GDP is an economic accounting identity comprised of four main components: personal consumption expenditures (“C”), investment (“I”), government spending (“G”) and net exports (exports minus imports, or “X-M”).

    The formula for GDP is C + I + G + X - M.

    Personal Consumption Expenditures

    Personal consumption expenditures are a comprehensive measure of consumer spending on goods and services. This component makes up about 68% of the U.S. economy and is the main driver of economic growth.

    Investment

    Gross private domestic investment, if done by businesses, is sometimes referred to as capital expenditures. This component represents residential housing construction and businesses' purchase of equipment, structures and changes in inventories.

    In 2013, the U.S. Bureau of Economic Analysis expanded coverage of intellectual property rights within the investment component of GDP to better capture businesses’ expenditures on research and development, and for entertainment, literary and artistic originals for which there is a long-lasting economic benefit. Investment makes up about 16% of the U.S. GDP.

    Government Spending

    This component measures all government consumption and investment, including the federal, state and local levels of government. For example, government consumption includes government employee salaries and the payments for goods and services, such as maintenance on the White House. Government investment includes the purchase of structures, equipment and software. Government spending makes up about 19% of the U.S. economy; it does not include transfer payments, such as Social Security.

    Net Exports

    This component represents the net value of a country's total exports minus the value of its total imports. This component is usually a net negative for GDP of about 3%, meaning that the United States usually imports more goods and services than it exports.


  • Are Social Security survivor benefits for children considered taxable income?
    A:

    Social Security survivor benefits for children are considered taxable income only for the children who are entitled to receive them, even if the checks are made out to a parent or guardian. Most children do not make enough in a year to owe any taxes.

    However, survivor benefits are taxed if half of the child's benefits in a year, added to any other income the child earns in the year, is enough to require him or her to file a tax return and pay taxes. If half of the annual benefits plus the child's other income exceeds a base amount determined by the IRS ($25,000 in 2018), then a portion of the benefits is taxable.

    Most checks for Social Security survivor benefits are made out to an adult, such as a parent, on the child's behalf. The amount of the benefits does not affect the income tax of the parent. If both the parent and the child receive benefits, the amount designated for the eligible child is subtracted from the check to determine the parent's tax liability. The child receiving the benefits may still be considered a dependent for tax purposes if he or she lives with the parent for more than half the year and the parent pays for more than half of his or her living expenses, such as food, housing, clothing, education and medical care.

    Social Security benefits are reported to the IRS. The recipient of the benefits receives an SSA-1099 form in January, including amounts of all benefits received during the previous year.

    For background, see Social Security Benefits for Children: How They Work.


  • Are spousal Social Security benefits retroactive?
    A:

    Spousal Social Security benefits are retroactive. These benefits are quite complicated, and anyone in this type of situation is advised to sit down with a financial counselor to review options. Some of the major factors that could impact this decision are the life expectancy of the spouse and recipient, age of retirement and living expenses.

    Retroactive

    Spousal Social Security benefits are retroactive and can be paid via a lump sum when the file-and-suspend strategy is used. When this option is used, the couple can retroactively receive benefits from the time of filing.

    This strategy is a hedge against some sort of health scare or change in life circumstances that requires lots of money. If this step is taken, the couple retroactively receives primary and spousal benefits that would have been paid out if they had been receiving monthly payments the whole time. However, the couple is then ineligible for the increased Social Security payments that are made when they receive benefits at the age of 70.

    Spousal Benefits

    Spousal Social Security benefits allow one spouse to file for benefits while the other spouse receives a benefit based on the filing spouse's benefit. The maximum a spouse can receive is half of the filing spouse's full benefits at the full retirement age.

    For most couples, the optimal balance is for both spouses to file for Social Security at the full retirement age and have the spousal Social Security benefit make up the difference. Spouses are entitled to collect 50% of Social Security benefits; however, this requires both spouses to file for Social Security even if they do not intend to collect.


  • Are spousal Social Security benefits taxable?
    A:

    Your spousal Social Security benefits may be taxable, depending on your total household income for the year. About one-third of those who receive Social Security benefits have to pay taxes on them. However, you do not pay taxes on more than 85% of your benefit amount.

    Total Income

    To determine whether you must pay taxes on your spousal Social Security benefits, first calculate your total income base. Then add one-half of your annual Social Security benefit amount to the total amount of all your other income. This includes other income includes wages from employment, as well as distributions taken from traditional 401(k) or IRA savings plans and any interest or dividends that you have earned on investments.

    Taxes due on your Social Security spousal benefits are in addition to any income tax you may owe on other income.

    Individual Income Threshold

    Because it is possible to collect spousal benefits on the Social Security account of an ex-spouse, you may be filing as an individual. If you file as an individual and your total income is less than $25,000, you do not need to pay taxes on your benefits. If your income is between $25,000 and $34,000, up to 50% of your benefits may be subject to tax. If your income is above $34,000, you may be taxed on up to 85% of your benefits.

    Married Income Threshold

    If you are married and filing jointly, you must include your spouse's total income even if she has deferred her own benefit payments to accrue delayed retirement credits. If your combined taxable income is less than $32,000, you are not required to pay taxes on your spousal benefits. If your income is between $32,000 and $44,000, you may be required to pay taxes on up to 50% of your benefits. If your household income is greater than $44,000, up to 85% of your benefits may be taxed.

    If you are married and file separately, you are likely to have to pay taxes on a portion of your benefits.


  • Are target-date retirement funds good investments?
    A:

    The main benefit of target-date retirement funds is convenience. If you really don't want to bother with your retirement savings, just check off the box with the fund corresponding to your desired retirement age. The money gradually moves from stocks to safe bonds as you age, presumably letting the money grow in your younger years while securing your nest egg as your retirement date grows near.

    Fund Structure

    A target-date fund (TDF) is actually a fund filled with other funds, almost always from the same fund company that offers the TDF. For example, a 40-year-old's TDF would typically contain something along the lines of 40% in a U.S. stock fund, 40% in an international stock fund and 20% in a bond fund. You could buy the exact same three funds individually, but then you'd have to rebalance the portfolio every couple of years as your retirement draws near. By contrast, the TDF is a prepackaged product that rebalances your investments automatically.

    Double Fees

    As usual, when the finance industry makes something easy and convenient, it means you're paying a premium. In this case, the TDF charges an annual fee on top of the underlying three funds. So if the three funds in the example above cost 0.5% each, and the TDF charges another 0.5%, you're getting hit with double fees year after year, which amounts to a sizable bite out of a six-figure nest egg.

    By comparison, a meeting with a financial advisor every couple of years only costs a fraction of the extra fund fees. It also has the benefit of providing you with an investment strategy that the advisor tailors specifically to your needs and desires.

    Bonds Drag Down Total Returns

    As interest rates have dropped in recent years, many experts also question the wisdom of the inclusion of bond funds in TDFs. For young people in particular, with 30+ years to retirement, being automatically steered to 10 to 20% bonds is questionable even with normal rates. With so many years of compounding, the lower return of those 10 to 20% of assets may mean tens of thousands less at retirement age.

    Elderly investors who are close to retirement are typically moved to 70 to 80% bonds, which lowers the risk but also the investment return. Experts suggest lowering the risk by diversifying into large-cap stock funds instead, arguing that the dividends paid by large-cap companies exceed bond yields. Meanwhile, spreading the holdings across many stocks in different countries lowers the risk comparably to bond funds. Bond yields are extremely low, and a nest egg placed largely in bonds struggles to keep pace with inflation as long as low interest rates persist.


  • Are the deferred earnings in a SIMPLE IRA subject to FICA taxes?
    A:

    While salary deferral contributions to a savings incentive match plan for employees of small employers (SIMPLE) IRAs and SIMPLE 401(k)s are not subject to income tax withholding, they are subject to tax under the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA) and the Railroad Retirement Act (RRTA).

    Coincidentally, employer matching and nonelective contributions are not subject to FICA, FUTA or RRTA taxes.

    To read more, visit Plans The Small Employer Can Establish, SIMPLE IRA Vs. SIMPLE 401(k ) and Introduction To Simple 401(k) Plans.

    This question was answered by Denise Appleby
    (Contact Denise)


  • Are there penalties for withdrawing monies invested in annuities?
    A:

    Annuities can be a great investment for retirement savings and estate planning, but they are often passed over due to the expenses and long-term contracts associated with this type of investment. If money is withdrawn from an annuity before the contract specifies, hefty penalties are assessed. Also, tax penalties may be involved when funds are withdrawn from an annuity. The amount of the penalty depends on the investor's age at the time of withdrawal, how long the investment has been held and the circumstances for making the withdrawal.

    Surrender Charges

    Annuity contracts are issued by insurance companies for a specified investment term, typically from four to seven years. For each year the investment is held, the penalty for early withdrawal changes, getting lower the longer the annuity is held. This is called a surrender schedule. It is not uncommon for an early withdrawal penalty made in the first few years of owning an annuity to exceed 5%.

    Tax Penalties

    In addition to penalties assessed by the insurance company, early withdrawals may also trigger an Internal Revenue Service (IRS) penalty. Annuities are considered a retirement product by the IRS, regardless of whether the contract is held in an Individual Retirement Account (IRA). Even non-qualified annuities require the owner reach the age of 59.5 before taking penalty-free distributions.

    Disability and Long-term Care Withdrawals

    Fortunately, as retirement accounts, annuities allow for early withdrawal with no penalty in the event the annuitant becomes disabled. Additionally, some contracts offer a benefit for taking penalty-free withdrawals to pay for long-term care expenses. Many contracts also let the owner withdraw up to 10% of the contract value or premium each year, as defined in the contract, penalty-free.


  • Are treasury bills a good investment for retirement savings?
    A:

    Making investment decisions for your retirement savings is all about balancing opportunity cost and risk. Treasury bills (T-bills) issued by the U.S. government are considered among the safest investments in the world, so risk should never be a significant deterrent. However, the return on T-bills is often quite low when compared to other types of securities; opportunity cost needs to be taken into account.

    Opportunity cost is a concept in microeconomics; it states that the real cost of any decision is the next-best alternative. For example, the opportunity cost of purchasing a $500 television is not really $500 but rather the next-best use of that $500, such as the returns it might have earned if it were invested. In the case of T-bills, the opportunity cost of investing is manifested in unrealized returns that might be had elsewhere in the market.

    A 25-year-old worker who invests in T-bills for his or her retirement is likely to earn only a fraction of what the average stock market returns would be over his or her next 40 working years. Since the worker is better able to absorb fluctuations in the market over the next several decades, there is very little reason to invest in T-bills for retirement.

    A 60-year-old worker, however, is a different story. With retirement much closer, Treasury bills offer a very real security for any funds saved up to this point. The worker has less time to recover any lost funds if he or she kept an aggressive portfolio, and the difference in returns between T-bills and equities is much smaller because there is much less time for the difference to compound. This is not to say that T-bills are necessarily the worker's best bet, especially since the maturities are less than a year, but they make more sense in his or her case.


  • Are variable annuities subject to required minimum distribution (RMD)?
    A:

    Variable annuities are insurance contracts that provide tax-deferred growth of assets that can later generate a guaranteed income stream, thus making them popular vehicles for financing retirement. Like other investment products, variable annuities can be held as either qualified or non-qualified for tax purposes.

    Qualified contracts – those held in IRAs or other tax-advantaged plans – are subject to the same required minimum distribution (RMD) rules as other investments in qualified retirement plans. Non-qualified contracts offer tax-deferred growth of after-tax funds and have no required withdrawals until annuitization, as defined by the annuity's contract.

    Effects of Required Distributions

    The Internal Revenue Service (IRS) requires owners of IRAs and other qualified retirement accounts to begin taking withdrawals once they reach the age of 70½. The amount of this RMD is determined by an age-based divisor and the balance in the account. A hefty penalty of 50% is imposed if the minimum is not withdrawn each year.

    Having to take withdrawals can create fear for retirees, as life expectancies lengthen and the possibility of outliving retirement savings increases. The guaranteed lifetime income rider available for purchase on some variable annuity policies can help solve this problem.

    RMD Effects on Benefits

    Distributions can negatively impact investment performance and sometimes other benefits to the annuity contract, such as lifetime income riders and death benefits. When evaluating a variable annuity for qualified monies, it is very important to understand how RMDs are treated and the effect they have on the policy.

    For example, MetLife offers its Guaranteed Minimum Income Benefit Plus rider on qualified contracts. As of 2018, this benefit treats RMDs as a percentage withdrawal against the guaranteed income base and not the total account value. This helps to maintain the investment's ability to grow.

    Required distributions should not stop investors from considering the valuable benefits offered by variable annuities. Investors and financial planners should work together to find a contract that works well with RMDs to maximize investment growth to last through retirement.


  • Benefits of a 401(k) for the Self-Employed
    A:

    If you are employed by a company that offers a 401(k) plan, it is best that you go through your employer to fund it, since you will accumulate savings faster. However, if your employer does not offer a plan or you are self-employed, you can set up your own plan. This type of retirement plan is called a solo 401(k) plan or independent 401(k) plan.

    In order to invest in a solo 401(k), you must meet certain requirements. The first requirement stipulates that you and not an employer are responsible for your income. Sole proprietors, small business owners without employees (though spouses can contribute if they work for the business), independent contractors and freelancers are the ideal solo investors. The second factor that must be met is presence of income. This can be verified through tax records. If you meet both criteria, you can open a solo 401(k) plan.

    Specific Steps

    According to the Internal Revenue Service, there are specific steps that must be taken in order to properly open a solo 401(k) plan. First, you have to adopt a plan in writing, which means you have to make a written declaration of the type of plan you intend to fund. You can choose between two types of retirement plans: traditional and Roth. With a traditional individual plan, you invest your dollars pre-tax, then when you reach retirement age, you pay taxes on the funds as you withdraw them. This allows you to invest more money upfront while lowering your taxes while you are still working.

    The downside to this is that when you are ready to withdraw your money, the tax rate could be higher than when you initially invested and the additional tax burden might erase any tax benefits received previously.

    Roth plans are funded with after-tax dollars. This could mean you have less to invest while still working, but since you've already given the IRS its cut, the plan's earnings are all yours when it's time to retire.

    CNN Money points out another benefit to the solo 401(k): Unlike an SEP IRA, another tax-advantaged account often recommended for small businesses/self-employed types, you can give yourself loans from the plan. It's not advisable to borrow from your retirement fund, but it's a decent option to have in case you need some quick cash.

    Once the type of plan has been established, you will need to create a trust that will hold the funds until you need them or you reach retirement age. According to the IRS, you can select an investment firm or insurance company to manage the plan for you. You will also need to establish an excellent record-keeping system for the plan so all investments are accounted for at all times.

    Just because you are a one-person outfit, a freelancer or an independent contractor, you don't have to go without a retirement plan. With proper planning and diligence, you will be able to enjoy a comfortable retirement after years of being your own boss and working on your own terms.


  • Calculating PV of annuity in Excel
    A:

    Calculating the present value of an annuity using Microsoft Excel is fairly straightforward. However, you have to know the annuity's terms: its interest rate, payment amount and duration. Also, the assumption here is that you're dealing with a fixed annuity. Variable annuities offer a rate of return that fluctuates, usually in tandem with some stock market or money market index; this makes it difficult to value, as you'd have to guess at future rates.

    Pricing a Fixed Annuity in Excel

    The price of a fixed annuity is the present value of all future cash flows. In other words, what is the amount we must pay today in order to receive the stated rate of return for the duration of the annuity? For example, if we wanted to receive $1,000 per month for the next 15 years, and the stated annuity rate was 4%, what would this cost us?

    Note: this calculation does not account for the income taxes due on the annuity payouts. (If the chart is hard to read, please right-click and choose "view image.")



  • Can a 401(k) be used for a house down payment?
    A:

    A 401(k) retirement plan can be tapped to raise a down payment for a house. You can either borrow money or make a withdrawal from your 401(k).

    Withdrawing From a 401(k)

    The first and least advantageous way is to simply withdraw the money outright. This is treated the same as a hardship withdrawal, meaning that you owe the full income tax as if it were any other type of regular income that year. This can be particularly unappealing if you are close to a higher tax bracket, as the withdrawal is simply added on top of the regular income. There's a 10% penalty tax on top of that if you are under 59.5 years of age.

    Borrowing From a 401(k)

    The second way is to borrow from the 401(k). You can borrow up to $50,000 or half the value of the account, whichever is less, as long as you are using the money for a home purchase. The interest rate for this loan is typically two points over the prime rate. You are effectively paying interest to yourself rather than to the bank.

    The downside is that you need to repay the loan, and the time frame is normally no more than five years. With a $50,000 loan, that's $833 a month plus interest. You must disclose this to the bank when you're applying for the rest of the loan, since it could potentially drive up your monthly expenses.

    If your employment ends before you can repay the loan, there's typically a 60- to 90-day repayment window for the full outstanding balance. Failure to repay the loan triggers the regular taxation and 10% penalty tax, as the outstanding balance is then considered to be an early withdrawal.


  • Can a divorced woman collect Social Security from her ex-husband?
    A:

    While a number of conditions must be met, a divorced woman is able to collect Social Security benefits through her ex-husband. The marriage must have lasted at least 10 years and the applicant cannot currently be married. The minimum age to collect benefits is 62, and the ex-husband must be entitled to Social Security retirement or disability benefits.

    How Much Are Ex-Wives Entitled To Receive?

    If a woman remarries and her second spouse dies, she qualifies to claim benefits from either her first husband or second husband as long as each marriage lasted at least 10 years. In this case, the benefit received is the highest amount of the two. In general, ex-wives are entitled to one-half of their ex-husbands' retirement benefits. If the man dies, the ex-wife receives his full retirement benefit. Some women relinquish their rights to Social Security on their ex-husbands' records by signing divorce decrees. If a marriage lasted at least 10 years, those clauses are meaningless and are never enforced.

    How Do You Apply for Benefits on an Ex-Husband’s Record?

    Apply for benefits online by going to SSA.gov, call the toll-free number or find the local office by going to SSA.gov and making an appointment. To apply for benefits on an ex-husband’s work record, you need to know his Social Security number or his date and place of birth and his parents’ names. To protect the privacy of all parties involved, the ex-husband is not notified when an ex-wife applies for Social Security benefits on his record.


  • Can a person who is retired continue to fund an IRA?
    A:

    For the purposes of contributing to an IRA, compensation (i.e. earned income) does not include income from a pension, an annuity or Social Security. Generally speaking, you must have earned the income by performing services (i.e. work) or received it as alimony and/or a separate maintenance for it to be considered compensation for the purposes of contributing to an IRA.

    This question was answered by Denise Appleby
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    Contact Denise)


  • Can a simplified employee pension (SEP) IRA be converted to a Roth IRA in the same manner that a Traditional IRA can?
    A:

    Yes. An SEP IRA can be converted to a Roth IRA.

    As you may know, an SEP IRA is just a Traditional IRA that receives employer SEP contributions. Once the SEP contributions are made to the account, they immediately assume the identity of regular Traditional IRA assets and are subject to the same set of rules.

    This question was answered by Denise Appleby
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    Contact Denise)


  • Can a spouse who is not named as a beneficiary receive assets from an IRA?
    A:

    It depends.

    Generally speaking, the designation of beneficiary form dictates who receives the assets from the individual retirement account (IRA). Therefore, no one else is entitled to receive any share of the IRA unless the named beneficiaries choose to disclaim their portions. However, if the IRA contributor resides in a community property state and the spouse did not approve the designation of beneficiary, he or she may be entitled to a portion of the IRA. Under the laws of these states, the spouse must be the primary designated beneficiary, unless he or she consents to another party being the primary designated beneficiary. The community and marital property states are Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

    If the contributor resides in one of these states, you'll need to check with the custodian to determine whether the proper approval was obtained from you (as the contributor's spouse). If the proper approval was obtained or if the contributor did not reside in one of these states, then the designated beneficiaries will be able to take possession of your share of the IRA.

    Note that even if the contributor resides in a community property state, the IRA (or a portion of it) may still not be subject to the community property laws if the balance was accrued before the person was married. To be sure, check with a local attorney who specializes in estate planning or tax law.

    (For more on IRA beneficiary designations, see Update Your Beneficiaries and Problematic Beneficiary Designations – Parts 1 and 2.)

    This question was answered by Denise Appleby founder of Appleby Retirement Consulting Inc.
    (Contact Denise)


  • Can a variable annuity be rolled into an IRA?
    A:

    You can roll qualified variable annuities – those established with pre-tax dollars – over into a traditional IRA. Qualified annuities are often set up by employers on behalf of their employees as part of a retirement plan. Non-qualified variable annuities – those established with after-tax dollars – are not eligible for a rollover to a traditional IRA, but you can move them into other types of non-qualified accounts.

    Characteristics of Variable Annuities

    A variable annuity is an investment vehicle combined with life insurance benefits. These products are popular in retirement planning because they offer tax-deferred growth and certain guarantees on principal, a future income stream and a death benefit for heirs.

    Like other investment products, a variable annuity can be held in either a taxable account or in a tax-advantaged qualified retirement plan. The funds within the variable annuity can be allocated across sub accounts, which are similar to mutual funds, for participation in the stock market or bond market. Combined with the unique benefit of guaranteed income, annuity contracts are useful as a pension replacement or as a supplement for many savers.

    Rolling Over an Annuity to an IRA

    Several employer retirement plans come in the form of a variable annuity contract, such as 457 or 403(b) plans, especially in the public sector. When people change jobs, they can still roll over one of these tax-sheltered annuities to a traditional IRA tax-free. As of Jan. 1, 2008, funds from these plans can also be converted to a Roth IRA, though taxes will be due on the amount converted.

    Variable annuities purchased outside of the workplace can also be rolled over to another qualified annuity via a 1035 exchange. This is a non-taxable transfer often used to gain access to a new annuity contract with different investment options, better riders or lower expenses. As long as the funds remain in qualified status, no taxes are incurred.


  • Can an individual contribute to both a Roth IRA and a Traditional IRA in the same year?
    A:

    Yes, you can contribute to both a Roth IRA and a traditional IRA in the same year. The total contribution into both cannot exceed $5,500 for individuals under 50, or $6,500 for those 50 and over. For example, a person 49 or younger can contribute $2,500 into a traditional IRA and $3,000 into a Roth IRA for the 2018 tax year. Additional conditions must meet IRS requirements as well.

    There are a number of factors to consider when deciding how much to contribute to either type of IRA:

    • Whether or not you can make contributions to a 401(k), 403(b) or other qualified retirement plan through your employer
    • Income limits for Roth IRA contributions
    • The current tax rate
    • Roth IRA and traditional IRA characteristics

    Retirement Plan Eligibility

    If you can contribute to your employer’s retirement plan, do that first. Once you are making the maximum contribution there, then you may want to consider making IRA or Roth IRA contributions. Here’s why:

    • Company retirement plans have higher contribution limits. For example, 401(k)s have a contribution limit of $18,500 compared to the $5,500 limit for IRAs.
    • Retirement plan contributions reduce your income taxes.
    • Many employers match your contributions, which is essentially free money.

    To find out if your company offers a retirement plan, contact your human resources department or talk to your manager.

    Income Limits for IRA Contributions

    As of 2018, you can make Roth IRA contributions if you have earned income and your taxable compensation is less than $135,000 if filing individually or $199,000 if you are married and filing jointly. There are no income limits for traditional IRAs.

    Distributions and Tax Implications

    Contributions into a Roth IRA are after-tax. As a result, assets in these accounts grow tax-free and all distributions are also tax-free. Contributions into a traditional IRA, on the other hand, are generally tax deductible, while all contributions and earnings are tax deferred. When distributions are made, they are taxable. After age 70.5 the IRS requires traditional IRA account holders to take annual withdrawals from their accounts, called required minimum distributions (RMDs).

    Contributions into Roth IRAs generally favor investors who are younger with lower taxable income. For example, a traditional IRA contribution is worth more to a person who earns $100,000 per year than a person who earns $35,000. That’s because the $5,500 contribution saves approximately $1,158 in federal income taxes for the person earning $100,000, and saves $752 for the person earning $35,000.  (For more, see: Roth IRA vs. Traditional IRA.)


  • Can dividends be paid out monthly?
    A:

    Although it is more common for dividends to be paid quarterly or annually, some stocks do pay monthly dividends.

    Dividends: The Basics

    Public companies pay dividends to their shareholders, typically in cash, as a means of expressing thanks for their continued support. Dividends are issued as a dollar amount paid per share of stock owned, so each investor receives a dividend commensurate with her ownership stake in the company.

    For example, if company ABC has seven million shares outstanding and declares a 50-cent dividend, it pays $3.5 million in total dividends. A shareholder who owns 2,000 shares receives $1,000.

    Dividend Income

    Investment in dividend stocks is a popular way to supplement existing income because it requires little effort. Though dividends are not guaranteed on ordinary shares of stock, many companies choose to pay dividends each year, or each month, as a way to demonstrate their continued profitability.

    In some cases, companies that have done quite well may choose to issue one very large dividend that can provide a generous windfall for big investors. In 2004, for example, Microsoft (MSFT) paid out an unprecedented $3 dividend per share, for a total of $32 billion.

    Benefits of Monthly Dividends

    If you are looking to maximize retirement income, stocks that pay monthly dividends can be a great help. Having a steady stream of income throughout the year makes balancing your day-to-day budget much easier.

    However, one of the chief benefits of monthly dividends is the opportunity for reinvestment and compounding. Dividend reinvestment is simply the practice of using dividend funds to purchase additional shares of stock.

    Many trading platforms offer the option of automatically reinvesting your dividends for you, meaning your investment grows without you even lifting a finger. As the number of shares you own grows, so does your dividend each year, assuming the company's dividends remain stable. When you retire, you can begin taking your monthly dividends in cash to supplement distributions from your 401(k) or IRA.

    (see also The Perks Of Dividend Reinvestment Plans)

    Who Pays Monthly Dividends?

    Companies in certain industries are more likely to pay monthly dividends than others, so it pays to do your research. Real estate investment trusts (REITs) receive income in the form of monthly rents, so it makes sense that some REITs also pay monthly dividend distributions.

    Other companies required by law to pay out the majority of their income to shareholders are likely candidates for monthly dividend payments, as they need to redistribute their earnings regularly to avoid taxation.

    Qualifying for a Dividend

    Many people purchase certain stocks specifically because of the likelihood of receiving dividends. However, timing is everything when it comes to qualifying. When a company declares a dividend, it also announces the ex-dividend date, which is the date after which any share purchases are ineligible for the current dividend.

    (read more Declarations, Ex-Dividends and Record Dates)

    If ABC declares an ex-dividend date of April 15, the owners of stock purchased on or after April 16 do not receive the dividend, for example. Instead, the dividend is paid to the shareholder who owned the stock prior to April 15, despite the fact he no longer has a financial interest in the company. (For a deeper discussion, see How and when are stock dividends paid out?)


  • Can I add my higher income spouse's name to my Roth IRA in order to raise our contribution limits?
    A:

    IRS rules prevent you from maintaining joint Roth IRA accounts. However, you may accomplish your goal of contributing larger amounts if your spouse establishes his or her own IRA.

    Please note, however, that if your tax filing status in 2017 is married filing separately, you are eligible to contribute to a Roth only if your modified adjusted gross income (MAGI) is less than $133,000; however, contributions are reduced starting at $118,000.

    For individuals whose 2017 tax filing status is married filing jointly, you are eligible only if your MAGI is less than $196,000; contributions are reduced starting at $186,000.

    SEE: Roth IRAs Tutorial

    To read more about IRAs, check out Roth vs. Traditional IRA: Which is right for you?, Roth 401(k) vs. Roth IRA: Is One Better? and Converting Traditional IRA Savings to a Roth IRA.

    This question was answered by Denise Appleby
    (Contact Denise)


  • Can I borrow from an IRA without penalty?
    Technically speaking - yes. The 60-day rollover rule applies to all types of IRAs. This 60-day rollover rule allows you to withdraw assets from your IRA and roll over the amount within 60 days. If the amount is rolled over within 60-days, the distribution (withdrawn amount) is not taxable or subject to the early distribution penalty.

    Note: This is technically not a ‘loan’, but a provision that allows temporary use of IRA savings outside of your IRA. This is – by definition, a ‘distribution’ and a ‘ rollover’ of the distributed amount.

    Some reminders:

    • Generally, you can perform an IRA-to-IRA rollover only once during a 12-month period. According to a recent tax court ruling, all of your traditional IRAs are treated as one IRA for this purpose as of January 1, 2015. Prior to this date, the IRS indicated that this rule applies separately to each of your IRAs involved in such a distribution/rollover.
    • The same assets you withdraw must be the same assets that you roll over to your IRA. For instance, if you withdraw cash, you must roll over cash.
    • Only eligible amounts can be rolled over

    This question was answered by Denise Appleby
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    Contact Denise)


  • Can I borrow from my annuity to put a down payment on a house?
    A:

    You can borrow from your annuity to put a down payment on a house, but be prepared to pay an assortment of fees and penalties. In fact, when figuring a way to fund your down payment, borrowing from an annuity should be a method of last resort.

    How Annuities Work

    An annuity is a unique investment vehicle in that it is managed by a life insurance company rather than a traditional brokerage house. You deposit money into an annuity during your working years, and the growth is tax-deferred until you begin taking distributions at retirement. At this point, both principal and interest are returned to you in a series of regular payments.

    Penalties and Surrender Charges

    The benefit of an annuity is it offers peace of mind in the form of regular, guaranteed income throughout your retirement years. However, the product comes with many drawbacks. The biggest is your inability to withdraw money before age 59.5 without incurring heavy fees and penalties.

    The Internal Revenue Service (IRS) is the first to penalize you for withdrawing from an annuity before reaching age 59.5. Typically, you face a 10% tax on any money you withdraw early. You also have to pay the ordinary income taxes, which were deferred to that point, on the withdrawn money.

    If you are buying or building your first home and borrowing from an annuity for the down payment, the IRS grants an exemption to the penalty tax. However, this exemption does not apply to the ordinary income tax.

    The insurance company levies its own penalty, called a surrender charge, on early withdrawals, and this can be as much as 20%. Unlike the IRS, insurance companies do not waive surrender charges so you can buy your first home.


  • Can I close my existing Roth IRA and invest in a new Roth IRA at a different financial institution without a tax penalty?
    A:

    If you withdraw your Roth IRA contribution, the amount will be tax and penalty free. If your initial contribution accrued earnings while in the Roth IRA and you also withdraw the earnings, the earnings will be subject to income tax. Furthermore, if you are under age 59.5, the withdrawal will be subject to an early distribution penalty as well, unless you meet an exception to the penalty. Both the tax and the penalty apply because your distribution is not a qualified distribution.

    As an alternative to withdrawing the amount, you may consider transferring the balance to a new financial institution with which you plan to establish a new Roth IRA. A transfer is a tax-free movement of assets between retirement plans. Your new financial institution will be able to assist you with the necessary paperwork to effect this transfer. Additionally, you could request a distribution of the assets and make a rollover contribution to your new Roth IRA within 60 days after your receive the distribution. A rollover is also a tax-free movement of assets between retirement plans.

    Please bear in mind that you must meet certain income requirements in order to make a Roth IRA contribution. For 2018 they are as follows:

    You are able to contribute 100% of compensation up to $5,500 ($6,500 if you are at least age 50 by the end of the year for which you are making the contribution) your modified adjusted gross income cannot exceed:

    • $135,000 if you are single (the $5,500 limit is reduced if you earn between $120,000 and $135,000)
    • $199,000 if you are married filing jointly (the $5,500 limit is reduced if you earn between $189,000 and $199,000)
    • $10,000 if you are married filing separately (the $5,500 limit is reduced if you earn between $0 and $10,000)

  • Can I collect Social Security if I still have a job?
    A:

    It's possible to collect Social Security while you are still employed. You can collect both Social Security retirement and survivorship benefits (though not at the same time) even if you are currently employed.


    Each year, the Social Security Administration (SSA) reviews the earnings for all Social Security recipients. Your benefit amount may be increased if your earnings during the prior year were higher than one of the years used to calculate the retirement benefit. This increase is paid out retroactively to the January after the income was earned. It can be beneficial to you and your family to receive higher benefits, as it can increase the benefits that you and your family or survivors receive later. Additionally, if you are currently the recipient of survivorship benefits, then the additional earnings could  lead to your retirement benefits being higher than your current survivorship benefits.

    Income Limits and Social Security Benefits

    If you have not reached full retirement age and earn more than the yearly limit, your benefit amount may be reduced. If you are under the full retirement age for the entire year, the SSA deducts $1 for every $2 that you earn over the yearly limit. The 2016 limit for this is $15,720.

    If you reach full retirement age within the year, the SSA deducts $1 for every $3 that you earn over the yearly limit. The 2016 limit for this is $41,880. This only includes income that you earned in the months prior to reaching retirement age.

    When you reach full retirement age, your income earnings no longer negatively impact your Social Security benefits, regardless of how much you earn. When the SSA recalculates your Social Security benefit amount, any months when your benefits were reduced or withheld are not included in the calculations.


  • Can I contribute to my company-sponsored 401(k) after the company's year-end but before its tax-filing date?
    A:

    Unlike IRAs, where contributions can be made for the previous year up to April 15 of the current year, salary deferral contributions generally apply to they year in which they are actually withheld from the participant's wages/salary. For instance, assume that an employee makes an election to defer part of the bonus he will receive for the year 2006. The bonus is based on his 2006 compensation but is paid on January 31, 2007. The amount deferred from the bonus will apply to his 2007 salary deferral contributions.

    To learn more on this topic, check out Making Salary Deferral Contributions - Part 1 and Part 2.

    This question was answered by Denise Appleby
    (Contact Denise)


  • Can I convert non-deductible contributions made to my Traditional IRA to a Roth IRA without being taxed?
    A:

    You can convert the contributions to a Roth IRA; however, a portion of the amount you convert to the Roth will be subject to income tax. When your Traditional IRA balance consists of deductible and non-deductible contributions, any amount distributed or converted from the Traditional IRA is pro-rated to include a taxable and non-taxable portion of the assets.

    You may figure the taxable amount by using the following formula:

    (Total Deductible Contribution/Total IRA Balance) x Distribution/Conversion Amount = Non-Taxable Amount

    Let's say you have non-deductible contributions of $8,000 in a Traditional IRA that have grown to $100,000. The taxable amount would be:

    (8,000/100,000) X 8, 000=640

    Of the $8,000 that you convert, $7,360 would be taxable ($8,000-640=$7,360).

    This rule applies even if the deductible amounts and non-deductible amounts are held in separate Traditional IRAs. Also note that if you maintain multiple Traditional IRAs, their total balances must be combined in the formula above to determine the amount that can be excluded from income (i.e. the amount that is non-taxable).

    Consult with your tax professional to ensure that the appropriate forms are filed and the calculations are accurate.

    Reminder: IRS Form 8606 must be filed for any tax years that you distribute assets from your Traditional IRA if any of your Traditional IRA balances include non-deductible contributions. IRS Form 8606 is used to help you determine the taxable portion of your distribution or conversion. The IRS may assess a $50 penalty for any failure to file Form 8606. The form is available at http://www.irs.gov/.

    This question was answered by Denise Appleby
    (Contact Denise)


  • Can I have a self-directed IRA or Roth IRA using the forex market?
    A:

    In the U.S., one of the best ways for individuals to protect their income from taxes and save for retirement is by using an individual retirement account (IRA). IRAs come in many forms that can be tailored to specific individual preferences. However, significant rules and regulations have been developed and initiated by the IRS and the U.S. Treasury department that can make the use of IRAs quite confusing. Two of the main IRAs are self-directed IRAs and Roth IRAs.

    Self-directed IRAs are ones that are controlled by the individual. These accounts are established between the individual opening the account and a stockbroker. The individual is then in control of all the money that he or she wishes to invest. Roth IRAs can be opened through a broker, mutual fund or bank. Contributions made toward a Roth IRA are made on an after-tax basis; however, the key to the Roth IRA is that it provides tax-free growth.

    Fortunately, individuals who have self-directed IRAs or Roth IRAs can trade in the forex market as an investment. In order to do this, a forex trading IRA must be opened. Individuals who do this benefit greatly from being able to day trade tax free. Using forex within a retirement plan also provides added diversification that can be used to add stability to an investor's returns. Furthermore, individuals who already have assets invested in other IRA accounts are able to transfer those assets into a forex IRA account by filling out the necessary paperwork.

    As with traditional IRAs, forex IRAs can either be self-directed by the individual opening the account, or managed by a professional forex manager.

    To learn more, see Tax-Saving Advice For IRA Holders, Ten Tips For Achieving Financial Security and Traditional IRA Deductibility Limits.


  • Can I leave my pension to my spouse when I pass away?
    A:

    In most cases, an individual with a pension plan should have the option to leave at least a portion of his or her pension to a surviving spouse and/or child. Oftentimes, this can be done by purchasing an option on the pension plan. However, depending on the specifics and conditions mentioned in the plan, the cost in implementing such a measure will be in the form of reduced benefits for the surviving spouse.

    One example would be a defined-benefit pension with joint and survivor options. In this case, the surviving spouse would be entitled to at least half of the benefits that were originally given to the couple. In a regular defined-benefit pension plan without options, benefits stop once the individual passes away, which means that benefit end sooner. The plan with joint and survivor options assumes that one member of the couple will survive; therefore, both types of pensions are designed to pay out a similar amount over time, which is why the monthly amount paid out on the pension with joint and survivor options is lower.


  • Can I roll a traditional IRA into a 529 college account for my grandchild?
    A:

    The short answer: Not without paying taxes. But as with much of the tax code, there are various nuisances and exemptions to expound. The IRS considers moving money from your IRA to a 529 plan as a distribution included in your taxable ordinary income. Beyond the ordinary income tax, you would also face an additional 10% tax penalty for the early withdrawal if you are not yet 59.5 years old. After those taxes, you could contribute what’s left to the 529 plan.

    Rather than opening the 529, you might consider using the IRA distribution for the education expense, as distributions from your IRA for the purposes of higher education are exempt from the 10% penalty. According to the IRS, penalty exempt expenses include “tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.” You should visit the IRS website to get a full breakdown of the exempt expenditures. Remember, the higher education expense would exempt you from the 10% penalty, but the distribution would still incur the ordinary income tax. In addition, the distribution may need to be included as income on any financial aid applications.

    Finally, you might consider opening a 529 plan and beginning to contribute from your regular income rather than your qualified plan. This way, you can avoid both the ordinary income and early withdrawal tax from your IRA and begin to grow the 529 plan. In addition, many states’ 529 plans allow the account owner to make a full or partial state income tax deduction for contributions to the plan. If you’re not sure of the best strategy for your particular state and situation, you should reach out to a financial advisor for guidance.  


  • Can I roll my 401(k) and/or IRA funds into a more liquid investment fund without penalty?
    A:

    Choosing your retirement plan investments requires the assistance of an expert who is able to analyze your options and to help you choose the investments that best suit your profile. The investment advisor will take into consideration your risk tolerance and how soon you plan to retire. Most employers offer investment advice free of charge to their employees. Some even extend this service to assets held outside of your retirement plan. Check with your employer regarding any investment advisory services they may provide.

    Speaking in general terms, you may be able to change your IRA investment(s), or even transfer your IRA to another financial institution that offers the types of investments you prefer. Check with your financial institution regarding its policies for allowing transfers, as there are some IRA products that require a minimum investment period in order to avoid early termination charges.

    The 401(k) plan is a different matter. You are able to withdraw assets from your 401(k) plan only if you experience a triggering event. For most 401(k) plans, the triggering events are the following:

    • Attaining retirement age (this is generally age 59.5, but could be either earlier or as late as age 65)
    • Termination of employment (you are no longer employed by the company that offers the 401(k) plan in question)
    • Death – in this case, your beneficiaries are allowed to distribute your assets
    • Disability – the document that governs the 401(k) plan generally provides a definition of "disability"; this may vary among plans
    • If your employer terminates the 401(k) plan and does not replace it with another qualified plan

    If none of these occurs, then you cannot withdraw assets from your 401(k) plan account unless the plan allows for an in-service withdrawal. An in-service withdrawal is one that can occur before you experience a triggering event.

    Some 401(k) plans limit in-service withdrawals to certain circumstances. For example, you may be allowed a withdrawal if you need the assets to pay medical expenses or your mortgage or rent. Your plan administrator will be able to explain whether your plan has these provisions and any applicable limitations.

    If you experience a triggering event, you may roll your 401(k) assets into a Traditional IRA or another qualified plan.

    IRA and 401(k) assets that are distributed and are not rolled to another IRA or eligible retirement plan will be subject to income tax and may also be subject to an early-withdrawal penalty.

    You should consult with a competent investment professional before taking action. There is usually a cost associated with any professional consultation (unless you can get it for free from your employer), but it may be well worth it.

    This question was answered by Denise Appleby
    (Contact Denise)


  • Can I roll over a 403b plan?
    A:

    Part or all of the funds in a 403(b) plan can be rolled into an eligible retirement plan. Rollovers into a traditional IRA or non-Roth retirement plan are generally tax free. Funds can go into a Roth IRA by direct rollover, subject to income tax, but not the early distribution penalty.

    Required minimum distributions (RMD), hardship distributions, corrective distributions and any payments spread over the plan participant's life, or 10 years, are not eligible to be rolled over.

    If the 403(b) account has both pre-tax and after-tax contributions in it, a distribution is considered to come from the pre-tax money, contributions and taxable earnings first. Any nontaxable portion of the distribution, including after-tax contributions, can be rolled into a traditional or Roth IRA or to another eligible plan that accounts separately for taxable and nontaxable contributions.

    For example, Bill's 403(b) consists solely of pre-tax contributions and earnings. Bill can request a direct rollover of some or all of the account into a traditional IRA, a 401(k), another 403(b) or a government-eligible 457 plan with no tax consequences. The transaction does have to be reported on his next income tax return. If he rolls it into a Roth IRA, the distribution will be taxable income to him.

    Direct rollovers, trustee to trustee, are not subject to withholding. Indirect rollovers, where a check is distributed to the plan participant, are subject to 20% withholding. For an indirect rollover to remain completely untaxed, the participant has to make up the withheld amount.

    For example, Bill has decided to request an indirect rollover of $10,000 from his 403(b). His plan trustee withholds 20%. Bill gets a check for $8,000. He has to come up with $2,000 from other sources, or his rollover will only be $8,000. The $2,000 will be taxable income to him, subject to an early distribution penalty if Bill is under age 59.5.


  • Can I roll over a profit-sharing plan to an SEP IRA account without suffering any tax penalties and liquidation of current positions held in this account?
    A:

    It depends.

    If the transaction is processed as a direct rollover to the SEP IRA, then no taxes will be withheld. Through a direct rollover, the assets are made payable to the SEP IRA custodian (or trustee or plan to which the assets are being rolled). If the transaction is processed as an indirect rollover - which means the assets are first distributed to the participant, who must then rollover the assets to the SEP IRA within 60 days - the administrator of the profit-sharing plan will withhold 20% of any portion of the distribution that is rollover eligible.

    Check with the SEP IRA custodian to determine their documentation requirements (if any) for processing the direct rollover. The administrator of the profit-sharing plan may also have special documentation that the participant must complete to initiate any distribution, including those processed as a direct rollover to another retirement plan. In addition, some plan administrators require the custodian to provide an acceptance letter verifying the type of account to which the assets will be credited.

    Provide the SEP IRA custodian with a copy of the most recent statement issued for the profit-sharing plan and ask that they identify any asset on the statement that cannot be held in their IRAs. If the custodian is able to hold all the assets that are currently being held in the profit-sharing plan, then all the assets may be rolled to the SEP IRA as they are. If the custodian is unable to hold any of the assets, then these cannot be rolled to the SEP IRA, and the participant may need to liquidate these assets to proceed with the rollover to the SEP IRA. Alternatively, the participant may shop around for a custodian that is able to hold all the assets.

    This question was answered by Denise Appleby
    (Contact Denise)


  • Can I take money from my 401(k) to pay taxes?
    A:

    Tax bills may be paid from a 401(k) through the loan provision if the plan allows for such loans, but the rules around 401(k) loans generally make it cost-prohibitive.

    Advantages

    401(k) loans may be advantageous due to the relatively easy access to plan balances. Borrowers generally do not need to explain to employers the reason for the loan and can be approved within a matter of days. Some plans also allow for hardship withdrawals, which do not need to be repaid, but the criteria for qualifying for such a withdrawal is higher than for a 401(k) loan. Borrowers normally do not need to go through any type of credit check when applying for a loan from their 401(k).

    Disadvantages

    Borrowing from a 401(k) plan has the potential for negatively impacting retirement planning. Money withdrawn from retirement plans forfeits the benefit of compounding returns and can potentially lose out on stock market gains during the period when the loan is outstanding. Loans from traditional 401(k) plans are subject to double taxation; loan repayments are made with after-tax dollars and are taxed again when withdrawn during retirement. In some cases, employers prohibit regular contributions until the loan is paid in full.

    401(k) borrowers are generally given up to five years to fully repay the loan. If the employee leaves his job during that period, the full outstanding loan balance becomes due within 60 days. Any balance not repaid in time is then considered an early withdrawal, which is subject to taxation and a 10% early withdrawal penalty.


  • Can I take my 401(k) in a lump sum?
    A:

    The simple answer is yes. The follow up question is whether a lump-sum withdrawal is a good idea. And the usual answer to that second question is no.

    Establishing a retirement savings plan during your working years is a necessary part of comprehensive financial planning. Retirement is one of the most significant financial objectives that you save toward while you earn a living. As employers transition away from traditional defined benefit plans (pensions), the burden of savings now rests on the shoulders of employees. To that end, retirement savings plans that are contribution-based are a common benefit offered to employees, typically in the form of a 401(k).

    Employer Responsibility

    The majority of employers and 401(k) plan sponsors provide sufficient direction to employees when they begin contributions to the plan. Some companies automatically enroll eligible workers in a 401(k) plan (they can opt out), while others let employees choose if and when they can participate. Employers often rely on a plan sponsor to educate employees about the benefits and limitations of a 401(k) plan. These sponsors, also known as plan custodians, are also tasked with educating eligible employees about the benefits of the plan, the investment selections available and the contribution limits. However, most employers and plan sponsors fall short of providing beneficial information when employees change jobs, retire or need to take money out of their plans.

    Lump-Sum Withdrawal Options

    If you currently work for an employer with an active 401(k) plan, you are limited to the lump-sum withdrawal options indicated in the original plan document. The most common lump-sum withdrawal provisions come in the form of a loan against your 401(k) balance or a hardship withdrawal. You repay a 401(k) loan through paycheck deferrals over time. The loan is capped at a certain percentage of your total 401(k) balance, typically 50%.

    "If you have a 401(k) plan with the ability to take out a loan, you can withdraw the funds tax free," says Kirk Chisholm, a wealth manager at Innovative Advisory Group in Lexington, Mass. "Of course, you will have to pay them back, but this allows you to borrow from your 401(k) account and pay yourself back the interest and principal over time."

    The other option is a hardship withdrawal, a lump-sum withdrawal based on financial need that you do not need to repay. When a 401(k) Hardship Withdrawal Makes Sense will explain the details. Both types of withdrawals may be subject to tax and penalties.

    Lump-sum withdrawal options are not as limited when you leave an employer for another job or if you retire. You can take a lump-sum distribution from a previous employer's 401(k) plan up to the total vested account balance. After placing a distribution request, the plan sponsor or custodian sends a check directly to you, and the account is closed with the custodian. If you have a Roth 401(k) balance, no taxes are withheld; pretax or traditional 401(k) plan sponsors withhold taxes from the balance before cutting the check. In either case, if you are under 59.5, you are subject to a 10% tax penalty for what the IRS considers to be an early withdrawal.

    Considerations for Withdrawals

    The greatest benefit of taking a lump-sum distribution from your 401(k) plan either at retirement or upon leaving an employer is the ability to access all of your retirement savings at once. The money is not restricted; you can use it however you see fit. You can reinvest it in a broader range of investments than those offered within the 401(k).

    Contributions to a 401(k) are tax-deferred; investment growth is not subject to capital gains tax each year. Once a lump-sum distribution is made, you lose the ability to earn on a tax-deferred basis, which could lead to lower investment returns over time.

    Having access to your full account balance all at once presents a much greater temptation to spend. It can be a challenge to implement self control, which may result in running out of money in retirement.

    Tax withholding on pretax 401(k) balances may not be enough to cover your total tax liability in the year when you receive your distribution, depending on your income tax bracket. A large tax bill further eats away at the lump sum you receive. See How to Minimize Taxes on 401(k) Withdrawals.