Paying Yourself First: Retirement Options for Individuals
By Zeb Elliott, CPA, SGA Team Member
Long gone are the days where a worker could rely on an employer pension plan to completely fund their retirement years. It is now the responsibility of the individual to properly plan and save for their retirement. For many individuals, saving for retirement and paying themselves first is an afterthought. This is especially true for self-employed individuals. According to a recent survey conducted by the Employee Benefit Research Institute, an alarming number of Americans have set aside less than $25,000 for their retirement. In another study conducted by PricewaterhouseCoopers, nearly three-fourths of baby boomers have less than $300,000 saved for retirement, and about 30 percent of all baby boomers have less than $50,000 saved.
Tax season is a smart time to sit down with your Sink, Gordon & Associates LLP tax advisor and identify your options when it comes to paying yourself first and saving for retirement. For individuals that may not have access to an employer pension, a 401(k) plan or a 403(b) plan, two common alternatives are the Traditional IRA and the Roth IRA.
Traditional IRAs, in general, provide the contributing taxpayer an upfront tax deduction for their contribution. However, when the taxpayer withdraws the money out of the account in retirement, all of it will be taxed at the taxpayer’s ordinary income tax rates (unless there is basis in the IRA). Basis occurs in an IRA fund if there were any nondeductible contributions made to the account at any point in time. The following are the basic rules regarding traditional IRAs:
Roth IRAs, on the other hand, are treated differently for tax purposes. With a Roth IRA, the taxpayer contributing to the account forgoes the tax deduction in the year contributed. However, when the funds are withdrawn in retirement, the entire distribution is tax-free. The following are the basic rules regarding Roth IRAs:
****Exception to income limitations: Implementing the back-door Roth IRA technique, where an individual that makes too much money to directly contribute to a Roth IRA, can contribute to a nondeductible Traditional IRA and then subsequently convert the nondeductible IRA to a Roth IRA. This is a move that is unrestricted by income limits and is currently an accepted practice in the eyes of the IRS. The only taxes due on the conversion would be on any appreciation in the investments since the date that the account was opened.
So which option is best for you? A lot of this decision is based on your own unique tax situation. Generally, if you are going to be in a higher tax bracket, it might make sense to contribute to a Traditional IRA (provided that a substantial deduction is allowed). The higher your tax bracket, the more your deduction is worth. If your tax bracket will be lower, a Roth IRA might make more sense, as you will be foregoing the upfront deduction for your contribution, while benefitting from tax-free withdrawals in retirement, (when you may be in a higher tax bracket). A Roth IRA also offers some added flexibility, as contributions can be withdrawn penalty and tax-free at any time. If you are in a pinch financially in the future, you would have access to your Roth IRA contributions without any adverse tax consequences.
Saving for your retirement is ultimately up to you and many times, requires additional funds beyond the retirement fund provided by your employer. However, working with the right tax professional can help take the guesswork out of the process. Please contact Sink, Gordon & Associates LLP today to discuss your options. Call our office at 785-537-0190 or email us at firstname.lastname@example.org to see how we can assist you in your retirement planning decisions.
Contributing Author: Zeb Elliott, CPA | EMAIL
Zeb has been with SGA since January 2011 and specializes in individual and business tax preparation and planning, and QuickBooks consulting and training. Professionally, Zeb is a member of both the American Institute of Certified Public Accountants and Kansas Society of Certified Public Accountants and became a Certified Public Accountant in 2013. Prior to entering the accounting industry, Zeb earned his Bachelor of Science in Business Administration in 2010 and Master of Accountancy from Kansas State University in 2014. Zeb holds several leadership positions within the community, serving on the Finance Committee for the Young Trustees of the Greater Manhattan Community Foundation and as Treasurer for the Friends of the Sunset Zoo. Outside of his commitments, Zeb devotes his time to his wife, Kilynn, and his son, Kannen. Zeb also enjoys being active and playing any type of sport, including golf, softball, and basketball, grilling, cheering on his Kansas City Chiefs and Royals, catching a good concert and reading about personal finance.