The IRA is the most common type of individual retirement account. Money deposited into a traditional IRA, and any associated growth, will remain untaxed until it is withdrawn, and IRS regulations prohibit withdrawals before age 59 1/2.
Withdrawals are considered income during the year in which they are taken. As of May 2010, contributions are limited to a maximum of $5,000 annually, with an additional $1,000 permitted for those over age 50. Contributions are tax-deductible, provided your income is below $55,000 if you are single, or $89,000 if you are married and file income taxes jointly.
401k
The 401k is the most common type of employer-sponsored retirement platform. Some of the rules, specifically those regarding when withdrawals may occur and the manner in which they are taxed, are identical to IRAs. Contribution maximums for a 401k are $16,500, as of May 2010, with an additional $5,500 permitted for employees over age 50, making the total maximum 401k contribution $22,000. Additionally, employers are permitted to make annual contributions to employee accounts to the maximum limit of 6 percent of each worker’s pretax salary. This amount is above and beyond the employee’s salary deferral contributions, and results in a different fund limit for each person.
Simple IRA
Simple IRAs have become increasingly popular, especially for small employers, because these account types are easier to set up, have fewer strict administrative and reporting requirements, and offer more flexibility regarding mandatory contributions. The simple IRA contribution limit is $11,500 per employee, as of May 2010, with an additional $2,500 permitted for employees over age 50. Employer contribution limits depend on whether or not the company chooses to match employee deposits up to 3 percent, or make a mandatory nonelective deposit of 2 percent. Regardless of the employer’s decision to make elective or nonelective contributions to employee retirement accounts, compensation limits have been established that limit employer deposit calculations to $245,000 of compensation. Employers are not required to make simple IRA deposits for amounts exceeding $4,900 per employee. Withdrawal limitations for simple IRAs are identical to the 401k and traditional IRAs.
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Annuities
Annuities are unique and versatile retirement-planning vehicles issued and maintained by insurance companies. Annuities placed within other types of qualified tax-advantaged retirement accounts are subject to the limits on each of those accounts. However, annuities can also be classified as nonqualified, resulting in significantly greater freedom and flexibility for investors. Nonqualified stand-alone annuities have no income restrictions or contribution limits imposed by the IRS. Unless the insurance carrier restricts deposits, investors are free to contribute any amount. However, deposits to nonqualified annuities do not result in tax deductions. Growth within annuities remains tax-free until it is withdrawn, at which time the amount of the withdrawals is included in the owner’s taxable income. Due to the tax advantages of annuities and their deferred growth, the IRS has placed the same limits on withdrawals, and will penalize investors for taking money prior to age 59 1/2.
Rationalization on Limitations
The IRS imposes limitations on the amount of money that can be contributed to certain types of retirement funds, along with restrictions on when withdrawals can be made. Money deposited into a retirement account has been earmarked for future use; therefore, not actually taken as income for the year in which it was earned. With the significant earning potential that exists within tax-deferred accounts, and the associated delay in paying taxes to the IRS, limits have been set to assure the government will get at least a minimum amount from taxpayers.