401Ks, IRAs, etc

Factual Questions
1

This question is motivated purely from curiosity (I have no intention of moving or getting a job south of the border), so I don’t need professional help, at least in this regard :smiley: .

Could you give me a rough overview of the US rules for retirement savings plans? I’m curious how much better or worse they are than Canadian ones.

What’s the difference between a 401K and an IRA (or other similar beasts - I vaguely recall other acronyms)?
How much can you put in one every year?
How do they interact with company pension plans?
Can you have multiple ones?
Can you set up one completely independently of your employer? (from some of the comments I’ve seen they almost sounded like you could only get them through your employer).
If you’re prepared to pay the tax can you withdraw from them prior to retirement?
Are there circumstances when you can withdraw from them without paying tax (e.g. buying a home)?
What (if anything) is required to happen when you reach retirement age? (what I have in mind is Canadian RRSPs turning into RIFs with mandatory withdrawals, or annuities)

2

I’m sure an expert will be along shortly, and I’m doing this purely from memory, but in the meantime:

My understanding is that a 401(k) is employer-provided, tax-deferred investment scheme in which the employee puts up most of the equity and the employer matches at least some of the employee contribution, with contributions made monthly as a percentage of the employee’s salary. A Plan Adminstrator usually manages the company’s 401(k) program. An IRA, which stands for Individual Retirement Account is a tax-deferred account that can be created for any individual, and provides an option for the saving of retirement funs for the self-employed or those without a pension or 401(k). Contributions can be made monthly, yearly or on an irregular basis.

Most 401(k)s I’ve seen consist of a basket of several money-market (interest-bearing) and mutual (equity-based) funds, plus maybe company stock, and the employee can decide how to distribute the monthly contributions. IRAs tend to be conventional money-market-type accounts, although equity-based IRAs are available as well.

Last I checked, the maximum was about $16K/year, but I’m not sure that’s correct.

Generally a company will have a pension fun or a 401(k), but not both.

You can certainly carry a 401(k) and multiple IRA accounts, with the total yearly tax-deferred contribution limited as mentioned above. I don’t know if there’s a specific rule on this, but in most cases you are only likely to be able to contribute to one 401(k) at a time, although you could have additional accounts to which you are not currently contributing. See below.

AFAIK, 401(k)s are obtained only through an employer.

Below a certain total contribution, you must close the account if you leave the employer, the funds remain tax-deferred if you roll them into an IRA or the 401(k) of a new employer. Above the total, if you leave the employer you can no longer contribute to the fund, but the existing balance will continue to accumulate interest and/or capital gains.

Yes, but in addition to the ordinary tax on the withdrawn amount there is a penalty; IIRC, the penalty is 10% of the principal withdrawn.

For a first-time home buy, you can withdraw up to $10,000 without incurring the penalty, but (I think) you must still pay tax on the withdrawn amount. I believe there is also a provision for medical emergencies. Some 401(k) administrators also allow loans from the account.

You can start pulling the money from a 401(k) or IRA after age 59 1/2 without penalty; the moneys withdrawn will be taxed as ordinary income. After age 70, I believe, you must withdraw a certain percentage amount per year.

3

Well this used to be a fairly straightforward question until about 1998 when the government decided to offer more options for us. Unfortunately with the new options came new tax laws, which weren’t always the easiest to understand.

There are more retirement plans than you mentioned, but I’ll just cover the more popular ones. First is the 401 K plan. This is set up through your employer, basically you make contributions to it tax free, and most of the time your employer will match them up to a certain dollar amount. The most that you used to be able to contribute was $14,000 a year and your employer could match up to 25% of your total compensation. I believe that this has changed but I’m not sure of the updated numbers.

If you leave your employer you usually must take your 401K with you. If you don’t want to roll it into another employers plan you can take out your own Individual Retirement Account, or IRA. Traditionally this account takes contributions from you that you can later deduct from your taxes assuming that, if you also have a 401K, that your income doesn’t exceed certain limits The down side of this is that you are only allowed to contribute $4000.00 per year into ALL of your IRAs (4500 if you’re over 50) You get taxed on these funds when you choose to withdraw them. There are penalties and taxes that amount to almost 50% of your withdrawals if you choose to withdrawal from either the 401K or IRA before age 59.5 Once you’ve reached 70.5 you MUST start taking certain amounts out.

One of the newest most popular accounts is called the Roth IRA. Basically it works like the regular IRA only you get taxed on it now, and when you withdraw the money, hopefully after lots of growth and compounding, its tax free. There are limits with these that you have to follow, however basically you can withdraw the principal in your Roth Account safely after 5? years. There is also no government stipulation as far as when you MUST take withdrawals. Since you’ve already paid the taxes on it you can leave it in forever if you’d like.

On preview I see that EL_Kabong has done a good job of covering your other points. As usual, before you do anything life changing, consult your tax advisor.

4

Thanks for the info! Like I said, I asked purely from curiosity. Sounds rather more complicated than our RRSPs and Group RRSPs.

Interesting.

5

Okay, now it’s your turn. Explain a little about RRSP.

6

Ick! :eek: I was hoping I wouldn’t get asked that - I know generally what the rules are but I am most emphatically not an expert!

You can contribute a certain maximum percentage of your employment income (I think it’s currently 18%, but I could be wrong) to an RRSP. If you also have a pension plan, that affects the maximum RRSP contribution you can make each year.

You can have as many RRSPs as you want - the limit is on the total contributions to all your RRSPs each year. I have a Group RRSP at work; no real difference from a tax point of view between it and an ordinary one - it’s just that my employer will match my contributions up to 3% of my salary. It’ll turn into an ordinary RRSP when I leave the company.

I can withdraw from an RRSP as long as I’m willing to pay the tax (RRSP providers will usually nail you with a service charge as well for withdrawals or transfers to another plan, but at least for the ones I have it’s a fixed small amount). You can withdraw without tax consequences for your first home; I’m pretty sure you have to put the money back into your RRSP within x years, but I don’t recall the details.

You are required to either withdraw your entire RRSP (and pay tax on all of it), turn it into an annuity, or turn it into a RIF (Retirement Income Fund) when you turn (I think) 71. The latter choice is the most common. RIFs have mandatory withdrawals but I don’t know the details; I’m not old enough (yet) to have paid much attention to the rules for RIFs. :slight_smile:

The closest sort-of equivalent that I can think of to your description of a Roth IRA would be a Registered Education Savings Plan, used to help save for your kids’ or grandkids’ education. Contributions to the RESP are taxable but any gains within the RESP are not (and the government currently makes a small contribution to an RESP themselves, to promote saving for your kids education).

Those are all the details I can recall. And, the standard caution - IANAFA; don’t trust what I said in your financial planning. :slight_smile:

7

Oops. Just remembered one more item. There are “Locked In Retirement Accounts”. I forgot about them because they’ve never applied to me. They’re basically RRSPs that you can not withdraw from prior to retirement; depending on the circumstances a company pension plan can get turned into one when you leave the company.

8

Roth IRAs get hit with the same tax and 10% penalties that 401ks get if you withdraw for anything other than
[ol]
[li]Being old (59 1/2)[/li][li]Being disabled[/li][li]Being dead (hey, it’s got a bullet point in the IRS’s version)[/li][li]Up to $10,000 for a “first home.”[/ol][/li]Also, IIRC, the “first home” thing doesn’t really have to be the first home you’ve ever owned; it just has to fit some arbitrary set of criteria that seem sort of first-homey to the IRS.

9

$14,000 is in fact the limit on employee contributions for 2005. If you happen to be over age 50, you could put in up to $18,000. The total contributions made to a plan on behalf of an individual (employer + employee contributions) can’t exceed the lesser of $42,000 or 100% of an employee’s comensation for the year.

Actually, this isn’t true. If your account balance in the plan exceeds $5,000 (or with new rules, more likely $1,000), you can’t be forced to begin taking your money out of the plan until you reach the plan’s retirement age. In practice though, very few do leave their money behind in their previous employer’s plan.

Assuming you met each plan’s eligibility requirements, you could certainly participate in multiple 401(k) plans. However, the $14,000 limit on salary deferrals applies to the individual, and not the plan. So you don’t get to defer $28,000 in total.

One wrinkle that hasn’t been mentioned yet…beginning 1/1/06, 401(k) plans will be able to adopt “Roth 401(k)” rules. This money would be treated the same as the previously mentioned Roth IRA money.