Make your retirement planning as tax-efficient as possible under today’s laws.
- Qualified savings plans and retirement accounts continue to offer taxpayers several options for saving for retirement.
- There are many additional opportunities and considerations for taxpayers to be mindful of in order to take full advantage of planning for retirement in the most tax-efficient manner.
- Recent legislation created some changes to the retirement plan landscape for individuals and small businesses
Over the past 50 years, there has been a dramatic shift in funding retirement for the average American. Most people rely on savings and few have pensions available to them. One of the most common ways to save is through a retirement savings plan offered by your employer; the most common being the 401(k) plan. These plans are designed to incent you to save every year, often with contributions from your employer so that you can maintain a comfortable lifestyle in retirement.
Understanding defined contribution plans
A 401(k) plan is one kind of defined contribution plan. In a defined contribution plan, the employer, employee, or both make regular contributions to the plan. The money is invested and taxes are deferred until withdrawal. The retirement benefit is the balance in the account. Other types of defined contribution plans include 403(b) plans, SEPs, and SIMPLE plans. In general, both employers and employees can contribute to these plans to a maximum of $57,000. Certain plan designs, such as including a profit sharing feature, can help self-employed and small business owners build up their own retirement nest egg and provide options for the deferral of taxable income, as well as enhanced employee benefit packages.
“Defining” defined benefit plans
A defined benefit plan, as the name suggests, is designed to fund a certain level of retirement income at a future date. It is funded by annual contributions based on the individual’s age, income, length of time until retirement, and rate of return on the fund’s investments. The contribution amount is determined each year by actuarial calculations. For 2020, the funded benefit payable at retirement can be as much as $230,000, based on up to $285,000 of annual compensation. The plan is funded entirely by employer contributions, which are generally 100% tax deductible. For a business owner close to retirement age, the required contribution can be considerable, along with the tax deduction. Annual contributions are mandatory, and if the business has other employees, contributions have to be made for them, too. However, plans can be set up with eligibility requirements to exclude, for example, employees who work fewer than 1,000 hours in a year. A defined benefit plan is more costly than many retirement plans, but allows for greater contributions than most other plans.
Please see important disclosures at the end of the article.
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