IRS Retirement Plan Limits
The average retiree will need to amass a nest egg capable of generating 80 percent of pre-retirement income, according to research from the Aon Corp. In today's environment of low interest rates and flat stock market returns, that requires a lot of saving. Fortunately, a number of plans provide tax incentives for taxpayers to save for retirement.
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Types of Retirement Plans
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Retirement plans come in two main varieties: Defined benefit plans and defined contribution plans. The most frequently referred to defined benefit plan is the traditional pension, in which companies contribute money in order to meet a defined future obligation to provide income for workers. In these plans, the company assumes the risk of poor investment performance, since it will have to make up any shortfall when it comes time to pay benefits. Defined contribution plans are those in which there is no targeted future income benefit--the only thing defined about these plans is the amount contributed on the front end. In defined contribution plans, workers bear the brunt of investment risk.
Individual Retirement Accounts
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There are two kinds of individual retirement accounts, or IRAs: traditional and Roth. Both have contribution limits of $5,000 per taxpayer per year. Taxpayers over 50 may contribute an additional "catch-up" contribution of $1,000 per year. You also can open an IRA for a non-working spouse. Eligibility may be limited: See IRS Publication 590 in the resources section for a full discussion of income qualifications.
Traditional IRA contributions are generally tax-deferred, but withdrawals during retirement are taxable as income. Roth IRA contributions are made with after-tax dollars, but income in retirement is tax-free. A 10 percent early withdrawal penalty may apply to withdrawals prior to age 59 1/2 for both plans.
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401k and 403b Plans
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These plans are workplace-sponsored retirement plans. Typically, an employee contributes a portion of his or her paycheck, tax-deferred. The employer may match part of this contribution, typically around 50 percent of contributions up to 6 percent of the worker's income. For rank-and-file workers, the maximum contribution limit for tax year 2010 was $16,500. Workers over age 50 can contribute another $5,500 in "catch-up" contributions.
All contributions are tax-deferred and accounts grow tax-deferred. Withdrawals in retirement are taxed as income, and a 10 percent early withdrawal penalty may apply to withdrawals prior to age 59 1/2. Highly compensated employees may have their ability to contribute to these plans restricted based upon employee participation. The more employees participate, the higher the contribution limits allowed for highly compensated people within the company.
A 403b plan is similar to a 401k plan, with similar limits. They are defined contribution plans for nonprofit and government agencies.
Simplified Employee Pension Plans
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Simplified Employee Pension plans are a type of workplace-sponsored IRA. Employers can contribute to IRAs for their workers, up to 25 percent of compensation or $49,000 per year, whichever is less.
SIMPLE IRAs
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SIMPLE IRAs are similar to 401k plans in structure and taxation, except that a 25 percent penalty applies to contributions withdrawn prior to age 59 1/2 for the first three years--after which time the penalty drops to 10 percent, in line with other retirement plans. They are designed to be easier for small businesses to administer and less expensive to set up than 401k plans.
Contribution limits to SIMPLE IRA plans are limited to $11,500 annually. If the employer also has another salary deferral program, such as a 401k or another SIMPLE, total contributions cannot exceed $16,500. Workers over 50 can contribute an additional $2,500 in "catch-up" contributions.
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