What is the best accumulation vehicle to help supplement your retirement?
Depends …Depends on what? Depends on your current income, and on your current marginal tax bracket. It also depends on how you feel about your future marginal tax bracket.
If you are convinced you will be in a lower bracket at retirement, a Traditional IRA can be great. Defer tax in a higher bracket, pay tax in a lower bracket. No brainer right? Not so fast. What if you don’t qualify because you are covered under a qualified plan and you make too much money?
Also, being in a lower bracket at retirement might not be a given. Many times people lose deductions at retirement. No more dependents, no mortgage interest deductions, lower charitable contributions, no business expenses. In addition they may be assuming Congress won’t raise taxes in the future. This could be wishful thinking.
A Section 401(k) plan is a special type of defined contribution, qualified retirement plan.
A 401(k) plan is a retirement plan under which a participant is allowed to defer compensation, and the employer contributes this elective deferral to the employee’s account within the employer-sponsored 401(k) plan. Sole proprietors and partners with employees may also sponsor and participate in 401(k) plans.
Here are some of the reasons for the popularity of 401(k) plans:
Elective deferrals (except Roth deferrals) are not included in the employee’s taxable income, which means contributions are made with before-tax dollars.
Funds accumulate income tax deferred.
Distributions from the plan may be income-taxed under the annuity rules or as a lump-sum distribution.
Employer contributions (if any) are tax deductible up to the prescribed limits.
Elective Salary Deferral Limits
The annual limits on elective salary deferrals into a 401(k) plan, and the additional “catch-up” contributions permitted for participants age 50 and over.
If the 401(k) plan permits, participants in qualified plans can make after-tax contributions to a Roth 401(k) account. Roth accounts inside qualified plans require separate accounting. This could increase administrative cost so a plan may not include a Roth account. If it is available, a Roth contribution to a qualified plan works just like a Roth IRA except: