Tax Advantaged Investment Options for Retirement

As you review your current financial situation, always be planning for the future. Regardless of the amount of time you have until retirement, there are several things to keep in mind. 

Social Security

Social Security is the federal program of benefits providing workers and their dependents with retirement income . The Social Security tax is used to pay the program. When you retire, be aware that you might be subject to taxation. If your modified AGI and one-half of your Social Security benefits exceeds $25,000 ($32,000 if you are married filing a joint return) your benefits will be taxed.
If you are married filing a separate return, you may be taxed on the whole amount.


The Pension Benefit Guarantee Corporation (PBGC), a federal agency, covers employer-sponsored pension plans. The insurance is for a monthly maximum amount of about $3,971.59 for a worker retiring at 65. When you retire and start taking money out of your retirement plan or retirement annuity, you should be aware of the tax impact of the distributions. You will be taxed on the distributions from your plan minus your "cost". The exact calculation of cost is complex, but is described in detail in IRS Publication 575, which is available on the IRS web site.


An annuity is an insurance contract that you purchase for future income. You are only taxed when you start taking distributions or if you withdraw funds from the account. All annuities are tax-deferred, meaning that the earnings from investments in these accounts grow tax-deferred until withdrawal. Annuity earnings are tax-deferred so they cannot be withdrawn without penalty until age 59 1/2 .

Distributions and withdrawals are taxed as income. If the distribution is made to the annuity-hold in a single lump sum payment, then the full amount is taxed as ordinary income for that year. If you annuitized the fixed income distributions, then part of the payment is considered principal-which won't be taxed-and part of it is considered interest earnings-which are taxed as ordinary income. Variable annuities are different, since the payments will vary according to the market value of your investments. Similarly to fixed income annuities, the principal portion of the distributions won't be taxed.

An annuity has a death benefit equivalent to the higher of the current value of the annuity or the amount you have paid into it . If the owner dies during the accumulation phase, his or her heirs will receive the accumulated amount in the annuity. This money is subject to ordinary income taxes in addition to estate taxes. If the owner purchased a term-certain annuity and the payout phase started, the beneficiary can receive payments until the end of that period.


Some companies offer a defined contribution plan called the 401(k). This allows employees to set aside tax-deferred income for retirement purposes and in some cases employers will match their contribution dollar-for-dollar.

Taking a distribution of the funds before age 59 1/2 will trigger a penalty tax. If you are under age 59 1/2 and take a distribution, you will owe taxes on that money in addition to a 10% penalty tax. So if you change jobs you have several options. Many employers will allow you to leave the money in the 401(k) if you have a balance of $5,000 or more. If your new employer also has a 401(k) plan, you might be able to transfer your old plan to the new. The last option is to transfer your money to an IRA, although you lose the chance to take loans against your new IRA account.


An IRA is a tax-deferred retirement account for an individual that allows you to set aside up to $4,000 a year until withdrawals are made . If you withdraw before the age of 59 1/2, there is a 10% penalty. Single individuals with a modified adjusted gross income greater than $99,000 can only make limited contributions. Individuals with an AGI above $114,000 cannot make contributions to an IRA account.


A Simplified Employee Pension Plan is an individual retirement account for a self employed person or a small company with less than 25 employees . Contributions are tax-deductible Employers are not required to make annual contributions; however, if they are made, all eligible employees must receive those contributions. Possible investments include stocks, mutual funds and bonds. Earnings on contributions are taxed until withdrawal.


The SIMPLE plan is a type of retirement plan that can be set up by small businesses with 100 or fewer employees who earned at least $5,000 in compensation for the year . The employees must not have any other type of retirement plan to be eligible to participate in the SIMPLE plan. It is a good option for a company because of its simple reporting requirements. The plan allows employees to make contributions to an IRA (up to $10,500 a year, indexed for inflation). The employer must either match employee contributions dollar-to-dollar up to 3% of each participating employee's compensation, or make a 2% contribution on behalf of each employee who earns at least $5,000 in compensation for the year.
By InvestorGuide Staff

Copyrighted 2020. Content published with author's permission.

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