The complex universe of retirement savings plans
Question: I’ve enjoyed your show for years and its real world personal financial advice. Why can I put more money each year into a 401(k) than I can an IRA? This is stupid. I’m currently a contract employee and can only put $6,000 a year into an IRA, since I’m 50 and can use the catch-up provision. Last year, as an employee of a company that offered a 401(k), I saved more than $12,000. Plus, my company matched very generously. Thanks, Ernie, Sunnyvale, CA
Answer: I can’t pretend to understand many of the rules and regulations involving our defined contribution-based retirement savings system. It’s Byzantine. It’s a disgrace. The 401(k) is the core pension for the private sector. The 403(b) is for non-profits, and 457s are for state and local government employees. There is the solo 401(k), also known as the individual 401(k), for the self-employed. All these plans come with a Roth version. The SEP IRA is mostly geared toward the self-employed. The SIMPLE IRA is for small- to medium-size companies. The traditional IRA and Roth IRA is another option for many families. There are exceptions and wrinkles to this brief summary, however.
Whatever the label, the goal of these plans is the same: to encourage retirement savings. Yet many of the plans come with different rules, regulations and quirks. For example, in 2012, a married couple in their 40s with an employer-sponsored pension plan and an adjusted gross income of up to $173,000 can make the maximum contribution of $5,000 into a Roth IRA. The income limit for the same couple who would like to put the maximum $5,000 contribution into a traditional IRA is $92,000. Go figure.
A worker in a company with a 401(k) enjoys a maximum contribution of $17,000, with an extra $5,500 for those 50 and over. Yet a stay-at-home spouse taking care of the kids and aging parents can set aside a maximum of $5,000 into an IRA — or $6,000, if 50 or older. The amount an employee can contribute into a SIMPLE IRA can’t exceed $11,500 for 2012, with an extra $2,500 for the 50 and over cohort. I could go on, but you get the point (echoing your sentiments).
We all know that America is aging and the living standards of future retirees are increasingly uncertain. We also realize it’s important to save for retirement. There are many aspects of our economy that are difficult to change and reform, such as health insurance.
It shouldn’t be difficult for Congress to dramatically simplify the retirement savings system, putting everyone — worker, self-employed, homemaker — under the same rules. Simplicity is an underappreciated virtue in finance.
That said, I wonder if you have looked into setting up a SEP IRA or a solo 401(k) for yourself, assuming you get a 1099 and you receive compensation as personal income, or if your business is a corporation and you get a W-2 from it. You can set aside a lot more money in a SEP and solo 401(k) than with the traditional IRA and Roth IRA.
The SEP and the solo 401(k) are both designed for the self-employed. The contribution limits between the two plans are fairly similar. For example, with the SEP, sole proprietors can contribute up to 20 percent of net self-employment income up to the SEP IRA contribution limit (which is $50,000 in 2012). The contribution limit is the same with a solo 401(k), but you can end up saving more than in the SEP, because of the way the annual contribution for the 401(k) is calculated.
There are trade-offs between the two retirement plans. In essence, the SEP is incredibly easy to establish and maintain. However, you can’t borrow against your SEP. The sole 401(k) isn’t as cheap to run and it’s more complex. In return, you might be able to save more. You can also borrow against the plan, up to half the value of the solo 401(k) to a maximum of $50,000.
I’d research these options and see if you qualify.
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