Have You Reviewed Your Retirement Plans Lately? Year-end Tax Tips

by George F. McClure

Just as you get regular checkups from your physician, you should revisit your retirement planning before the end of every year. Time is of the essence. If you have self-employment income, for example, you must establish some plans before year-end, even if you will not fund them until tax time in 2005.

For salaried employees, once you determine the pay deduction amounts you want to fund your 401k, 403b or 457 salary reduction plan and the investment options you prefer, things essentially go on automatic pilot. You can take advantage of employer contributions to your plan — which is "found money" — by making the maximum contributions allowable. Even if your pre-tax contributions are held down, you may be able to make further after-tax contributions to these plans. In these cases, the growth on those contributions is tax-deferred as well, and you can get the after-tax contributions returned to you when you leave the plan.

Contribution Limits for 2004 and 2005

Source: www.401khelpcenter.com/2005_limits.html

In addition to the salary reduction plan available through work, all taxpayers have access to Individual Retirement Arrangements (IRAs) to save more for retirement. The base annual contribution is $3,000 ($3,500 if age 50 or older) and joint filers can make similar contributions for non-working spouses. Taxpayers have two options: a traditional IRA or a Roth IRA.

Traditional IRAs

With a traditional IRA, contributions can be deducted from your taxable income. All funds in the account are taxable at normal tax rates when distributions are made after retirement. You cannot contribute to a traditional IRA after you reach age 70-1/2; you have to start mandatory distributions at that time. In addition, tax deductibility may be limited, if you or your spouse is covered by an employer retirement plan (see IRS Publication 590, www.irs.gov/pub/irs-pdf/p590.pdf).

In addition, you can borrow funds from a traditional IRA for periods up to 60 days, but if you keep the funds out longer, they are considered to be a taxable distribution, and if you are younger than 59-1/2, you will pay a penalty.

Roth IRAs

Contribution limits for Roth IRAs are the same as for traditional IRAs and are subject to certain income limits. The contributions are not tax-deductible, but qualified distributions are tax-free. There are no mandatory distribution requirements, and you can continue making contributions past age 70-1/2, to the extent of taxable income.

Self-Employment Income Plans

If you are fully self-employed or have a side business that generates taxable income, you can set up other retirement plans. IRS Publication 560 provides details (www.irs.gov/pub/irs-pdf/p560.pdf).

Simplified Employee Pension (SEP) Plans

Simplified Employee Pension (SEP) IRA plans are easy to set up. The contribution limit is 25 percent of compensation, up to $41,000 for 2004. Similar to a traditional IRA, as an employer, you can make contributions forming a SEP IRA. And while SEP IRAs cannot be designated as Roth IRAs, contributions to SEP IRAs do not affect the amount you can contribute to a separate Roth IRA.

Savings Incentive Match Plan for Employees (SIMPLE)

SIMPLE (Savings Incentive Match Plan for Employees) salary reduction plans have been available since 1997. You can set up a SIMPLE IRA or SIMPLE 401k plan if you employ one to 100 people (including yourself).

A SIMPLE IRA is available to any employee who earned at least $5,000 during the preceding two years and is expected to earn at least $5,000 during the current year. The maximum contribution is $9,000 in 2004, but an employee aged 50 or older can make catch-up contributions of up to $1,500 more per year.

In a SIMPLE 401k plan, the employer must make matching contributions up to 3 percent. The contribution limits are the same as for the SIMPLE IRA, but a limit of $200,000 in compensation applies in figuring contributions. Non-discrimination rules do not apply.

SIMPLE 401k plans offer several advantages. First, vesting is immediate for all contributions. In addition, participant loans and hardship withdrawals add flexibility. Finally, SIMPLE 401k plans are easy to administer. On the other hand, though, employers must complete a Form 5500 report each year, and plan administrators must pay an annual fee.

Qualified Plans

The IRS must approve a retirement plan if it is to qualify for tax-deferred treatment. Self-employed individuals sometimes use either defined-benefit or defined-contribution Keogh plans. While you can have more than one qualified plan, your contributions to all must not total more than the limits imposed in Publication 560.

Keogh plans must be established before the end of the year for which a contribution is made. However, the contribution for any year can be delayed until later, but not later than the due date of the taxpayer’s individual return (including extension). Participants must file Form 5500 for the year the plan assets reach $100,000 and every year thereafter, for as long as the plan exists.

Solo 401k

If you operate your own business but employ only yourself and maybe your spouse, consider the Solo 401k plan, also called Self-Employed 401k or Individual 401k, which became available after the 2001 tax law changes. You can fund Solo 401k plans initially with a rollover from an IRA or other tax-deferred plan.

Solo 401ks offer generous contribution limits and allow for loans of up to $50,000 or 50 percent of the plan assets. These loans may extend for years at prime rate, but the interest paid is not tax-deductible. The deadline to establish a Solo 401k is 31 December or the end of the business tax year, whichever comes first (www.smartmoney.com/taxmatters/index.cfm?story=20021031).

George F. McClure is chair of the IEEE-USA Communications Committee and a past chair of the IEEE Member Conduct Committee. He can be contacted at todaysengineer@ieee.org. Opinions expressed in this article are the author’s.