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Retirement Planning Investment Solutions offered by Clifford & Rano Associates:
Traditional and Roth §403(b) Accounts [Top]
Traditional §403(b) Accounts
Employees of schools, hospitals and other not-for-profit organizations may take advantage of their employers' §403(b) plan to save for retirement. With a traditional §403(b) account, contributions are made on a pre-tax basis. This reduces your tax liability for the years in which you contribute to the plan, and all contributions are treated as tax-deferred until they are withdrawn. This way, taxes will not erode your account, allowing more of your savings to work for you over time. Employees may participate in a §403(b) program through payroll deduction, meaning contributions can be taken right out of your paycheck. And, §403(b) plan participants may choose from a wide variety of investment options, including mutual funds.
Roth §403(b) Accounts
Roth §403(b) accounts offer the option to build tax-free retirement income. While Roth §403(b) accounts are funded with after-tax dollars, all qualified distributions are tax-free.*
All employees who are eligible to make salary deferrals to a regular §403(b) account are also eligible to defer to a Roth §403(b) account. Contributions may be made to a Roth §403(b) in addition to, or in place of regular §403(b) account contributions, and your annual elective deferral limit may be divided between the two accounts in any manner you wish. However, once Salary Reduction Agreements have been signed and contributions have been deposited, participants may not transfer monies from one type of account to the other.
As with regular §403(b) accounts, employees may fund their Roth 403(b)s through payroll deduction, meaning contributions can be taken right out of your paycheck. Roth §403(b) accountholders may choose from a variety of investment options, including mutual funds.
Distributions may begin at age 59½ (provided the account has been funded for at least five years). And, while regular §403(b) account distributions are mandatory at age 70½, Roth §403(b) distributions are not mandatory until death if the account is rolled over to a Roth IRA.
Furthermore, a Roth §403(b) account can provide highly compensated individuals who may not be eligible to contribute to a Roth IRA with the opportunity to diversify their retirement assets.
*In order for the Roth §403(b) account to be distributed tax-free, it must be funded for a minimum of five years and distributions cannot be taken before the accountholder attains age 59½. A participant would also qualify for tax-free distributions if the account was held for five years and the account owner became disabled (under the strict definition of disability of §72(p) of the IRS code). Furthermore, in the event of the accountholder’s death, beneficiaries would receive tax-free distributions if the account was held for at least five years. Otherwise, the distribution would be treated as part return of principal and part taxable earnings. A 10% premature withdrawal penalty may apply to the earnings.
Individual Retirement Accounts (IRA) / Roth IRA [Top]
Traditional IRA
Anyone under the age of 70½ who has earned income (or the non-working spouse of such an individual) can make a Traditional IRA contribution. The only question is whether or not the contribution can be deducted for tax purposes. This hinges on whether the individual is an active participant in an employer-sponsored retirement plan or not. Ask your Clifford & Rano Advisor to show you the Legend IRA Roadmap to determine whether you (or your non-working spouse) are eligible to deduct a Traditional IRA contribution. If you cannot deduct a contribution, it makes more sense to make a Roth IRA contribution. It also might be preferable to make a Roth IRA contribution if your annual gross income (AGI) is within the Roth eligibility limits rather than to make a nondeductible Traditional IRA contribution.
Roth IRA
While Roth IRAs do not give the taxpayer a deduction, the earnings grow tax free, provided certain requirements are met. There are no age restrictions, but there are income limits. Contributions can be made by single individuals with an annual gross income (AGI) under $105,000 but not over $120,000, and by married individuals with an AGI under $167,000 but not over $177,000. Ask your Clifford & Rano Advisor to show you the Legend IRA Roadmap to determine whether you (or your non-working spouse) are eligible to contribute to a Roth IRA.
Maximum Contributions for Traditional & Roth IRAs
The maximum amount you can contribute to individual IRAs (Traditional plus Roth IRAs combined) is $5,000 in 2009 and 2010. The Economic Growth and Tax Reconciliation Relief Act of 2001 introduced the Over-Age-50 Catch-Up, which allows an individual attaining age 50 or more to contribute an extra $1,000 in 2009 to 2010. Contributions may be funded up to April 15th to be eligible for the previous tax year.
Legend Advantage Retirement Account
This tax-sheltered account enables participants to invest in multiple mutual funds from different fund families in a single IRA, Roth IRA, §457, §403(b) or Roth §403(b) account. The Legend Advantage Retirement Account includes a Periodic Rebalancing Option known as PRO. This feature may help investors to maintain a diversified investment portfolio. With PRO, investors specify how assets are to be allocated within their portfolios.
For-Profit Retirement Plans
SEP-IRA, SIMPLE IRA, §401(k), Profit Sharing and Money Purchase Pension Plans.
Simplified Employee Pension (SEP) [Top]
SEP is an acronym for Simplified Employee Pension. Since their introduction in 1978, SEP IRAs have gained tremendous popularity, particularly as a plan for sole proprietors. This is due to the fact that the only contributions allowed under a SEP IRA are employer contributions. Employer SEP contributions are deposited into an employee’s Traditional IRA account. If an employer is making a contribution for his or herself, expressed as a percentage of the compensation, he or she must also make a like contribution for all eligible employees. This means that the same percentage of their compensation must be contributed for their benefit. The most restrictive the employer can be in determining eligibility is requiring an employee to have earned $550 in any three of the last five years and be 21 or older in order to participate in employer contributions.
If an employer has adopted a prototype SEP IRA, such as those offered by a mutual fund family, brokerage house or insurance company, all contributions must go to that vendor. If the employer has adopted the IRS model 5305-SEP, the employee may set up an IRA with any vendor he chooses and the employer must send the contribution to that vendor.
The maximum that an employer can contribute in 2010 to an employee’s SEP IRA is the lesser of $49,000 or 25% of the employee’s salary, and the maximum salary that can be included in this calculation is $245,000. (These limits are subject to cost-of-living adjustments each year.) If the employee in question is a sole proprietor using Schedule C, the 25% of salary translates into a formula as follows: net worth on Schedule C minus ½ the individual’s Self Employment Tax times 20%.
SIMPLE IRA [Top]
SIMPLE IRAs were introduced by the Small Business Job Protection Act of 1996. They first became effective in 1997, replacing the SAR SEP plan. A SIMPLE IRA can be adopted by an employer with under 100 employees as long as no other retirement plan is maintained in the same calendar year other than one for a union, which is subject to a collective bargaining agreement.
An employee can defer up to $11,500 in 2010 to his/her SIMPLE IRA account established pursuant to the employer’s SIMPLE plan. The Economic Growth and Tax Reconciliation Relief Act of 2001 introduced the Over-Age-50 Catch-Up, which allows an individual attaining age 50 or more to defer an extra $2,500 in 2010. (These limits are subject to cost-of-living adjustments each year.)
An employer must make a contribution to the SIMPLE IRA plan – either a 3% matching contribution or a 2% non-elective contribution. The most restrictive an employer can be in determining eligibility is requiring an employee to earn at least $5,000 with the employer in any two of the last five years, and to be reasonably expected to make $5,000 in the current year.
401(k) Plan [Top]
The 401(k) Plan was named after a section of the 1978 Internal Revenue Code; a 401(k) is an employer-sponsored qualified retirement savings plan. The federal government established the 401(k) in 1981 with special tax advantages to encourage people to prepare for retirement. A 401(k) allows you to save for your retirement, while deferring any immediate income taxes on both the money you save and on your investment earnings until withdrawn.
Through a 401(k), you can authorize your employer to deduct a certain amount of money from your paycheck, before taxes are calculated, and to invest it in the 401(k) plan. Your money is invested in the options that you choose from the ones offered through your company's plan.
The amount you invest in your 401(k) cannot exceed the annual IRS dollar limit, which is $16,500 in 2010. Cost of living adjustments, applied in $500 increments, may increase standard limits in future years. It's important to remember that your employer-sponsored retirement plan(s) may have additional limits. Some plans allow you to contribute on an after-tax basis as well. After-tax contributions also have a maximum limit determined by the IRS.
Some companies offer a "match" or "matching contribution" as an incentive to join the company retirement plan. It means that the company will contribute a certain amount to your account (usually between $0.25 and $1.00) for every dollar that you contribute, up to a certain limit. The match formula can vary. To receive the matching contribution, the plan may require that you work a specified number of years. It makes good sense to take advantage of a company match by setting aside the maximum amount required to qualify for a matching contribution. If your employer offers a matching contribution, your savings can grow that much faster.
Profit Sharing Plans [Top]
Profit Sharing Plans can be adopted by all types of businesses. Any employee with 1,000 hours of service within one year and who is age 21 or older is typically covered under this plan, if the plan is in place. If immediate 100% vesting is offered, two years of service may be required. The employer’s contribution is a flexible contribution; however, employers must make “substantial and recurring” contributions.
The maximum total plan contribution that the employer can deduct is 25% of total eligible payroll (maximum eligible pay per participant is $245,000 in 2010). The maximum annual allocation to the participant’s account is 100% of participant’s total pay or $49,000 in 2010, whichever is less. This includes both employer and participant’s contributions. No participant deferrals are allowed without adding a 401(k) feature.
The benefit to employers is that the flexible contribution requirements allow employers to adjust their yearly contributions depending on the profitability of the company, as long as those contributions are “frequent and ongoing.” Tying employer contributions to company performance provides participant’s with an incentive to help make the business profitable.
Money Purchase Pension Plans [Top]
Money Purchase Pension Plans can be adopted by all types of businesses. Any employee with 1,000 hours of service within one year and who is 21 or older is typically covered under this plan, if the plan is instated. If immediate 100% vesting is offered, two years of service may be required. The employer contribution is nondiscretionary. The maximum total plan contribution that the employer can deduct is 25% of the participant’s pay. The maximum eligible pay per participant is $245,000 for 2010. There are no participant deferrals allowed in this plan. The benefit to the employer is that the fixed annual contribution requirements make it easier to budget retirement plan expense. This benefits the participant by offering a measure of comfort that money is being accumulated for their retirement.
The Benefits of Retirement Investing for Pre-Tax Account Holders [Top]
Pre-Tax Savings
Participants who defer compensation into §403(b) retirement accounts realize immediate tax savings on their contributions. Before any taxes are taken out, your paycheck is reduced by the amount you decide to invest. Therefore your total taxable income is less.
The Power of Pre-Tax Contributions (Example*)
Emily and Kent both earn $2000 per month, and both save $200 each month towards their retirement. However, Emily has the opportunity to invest in a §403(b) plan, while Kent's retirement contributions are made to an after-tax savings program.
Paycheck Analysis |
|
KENT |
EMILY |
|
|
After-Tax |
§403(b) |
|
Gross Earnings |
$2000 |
$2000 |
|
Retirement Savings |
200 |
200 |
|
Taxable Income |
2000 |
1800 |
|
Federal Withholding |
500 |
450 |
|
State Withholding |
100 |
90 |
|
7.65% FICA |
153 |
153 |
|
Net take home after savings |
$1,047 |
$1,107 |
|
Assumes a 5% state and 25% federal tax rate. |
*This illustration is hypothetical only and does not represent any particular situation. Taxes are still due on amount deferred upon distribution on funds. |
Since Kent's investments are not tax-deferred, he will have $2000 of taxable income for the month. Under current income tax rates, approximately $500 would go to the federal government, $100 would be withheld for state taxes, and FICA would be about another $153. As Kent is saving $200 a month for retirement, he would be left with $1,047 in spendable income.
Since Emily contributes $200 to a §403(b) retirement savings plan, her taxable income is only $1800. As such, her taxes will be less than Kent's with about $450 going to the federal government, $90 withheld for the state, and FICA remaining at $153. Since Emily has reduced her taxable income by contributing to her §403(b), her spendable income is $1,107.
As you can see, even though Emily and Kent are each saving the same amount for retirement, Emily is able to take home $60 more dollars per pay period because she is investing on a pre-tax basis in her §403(b) account. |
Tax-deferred Growth Potential [Top]
Taxes on your §403(b) investment earnings are also deferred. You needn't pay taxes on anything that your deferred compensation earns until you retire. For many people, that time is years away, allowing for long-term investment growth. Withdrawals are taxed as ordinary income, but many retirees find themselves in a lower tax bracket than when they were working. (A 10% penalty may apply for early withdrawal from a §403(b) account — i.e., before age 59½ unless taking advantage of a §72(t) distribution. Ask your Clifford & Rano Advisor for details.)
The Power of Tax-Deferred Compounding (Example*)
In this hypothetical illustration, we'll analyze the scenario for a monthly contribution of $250 into a §403(b) plan that is earning 8% APR versus the same monthly contribution and earnings rate in a taxable investment with a 25% tax rate.
*This hypothetical illustration is not intended to illustrate the performance of an actual investment. This illustration is not a guarantee of future performance. It shows a constant return rate of return, whereas actual rates may fluctuate. Fees and expenses have not been taken into consideration for the purpose of this illustration.
A taxpayer saving in a taxable investment would first have to pay tax on the $250 earmarked for saving, netting only $187.50 for deposit each month. In 10 years, the taxable investment would have grown to $30,970, while the §403(b) investment would be at $34,531, net after taxes — a difference of $3,561. The difference is that in the taxable investment, taxes were paid on all of the gains, thus reducing the amount saved. With the §403(b) plan, the entire investment was permitted to grow tax-deferred.
Over a period of 30 years, the difference is even more dramatic. Here the taxable investment grows to just $191,250, while the tax-deferred investment grows to $281,305, net after taxes. The difference is $90,055!
All the funds that were paid out from the taxable investment to cover the taxes were allowed to remain in the tax-deferred §403(b) investment to compound over all those years. With a §403(b) account or any other pre-tax savings retirement account, those funds were working for the investor throughout that entire period of time. And, while §403(b) assets are subject to taxes upon withdrawal, investors often find themselves in a lower tax bracket at retirement than when they were working. This means the amount paid in taxes should be less. |
Dollar Cost Averaging & Payroll Deduction Plans [Top]
You may have heard it said that investment success results from time in the market, not timing the market. While buying low and selling high is ideal, it is nearly impossible to predict exactly when the market will rise or fall. That’s why many long-term investors utilize a pre-tax savings, payroll reduction plan with built-in dollar cost averaging.
Dollar cost averaging is the practice of investing a set amount of money in the same investment at regular intervals. In the case of a payroll reduction plan, you would defer a certain percentage of your compensation each pay period to be invested in your retirement account. This amount is automatically deducted from your paycheck at regular intervals. Dollar cost averaging helps to minimize the effect of market volatility on your retirement investment, and is widely accepted as a sound long-term investment strategy in both rising and falling markets.
How Dollar Cost Averaging Works
With dollar cost averaging, when prices are low, your investment will purchase more shares — shares that can grow in value when the market recovers. Of course when prices rise, fewer shares will be purchased. But over time, the average amount paid for each share (average cost per share) will usually be less than the average price per share.
Since dollar cost averaging requires identical investments to be made at pre-determined times, the strategy eliminates the decision of when to invest. Also, by developing a regular schedule for investment contributions, you are more likely to stick to the discipline of your investment plan.
Dollar cost averaging enables you to begin a retirement savings program with a series of small contributions. The strategy is best suited to long-term investors with the fortitude to keep investing when the market falls, and to resist selling when the market rises. Dollar cost averaging does not ensure a profit, nor does it protect from loss during declining markets. Investors should consider their ability to purchase shares continuously during period of falling share prices.
How Does Dollar Cost Averaging Work in a Declining Market? (Example*)
Let’s say you decide to make a monthly retirement investment of $400 for a period of six months. During that time, share prices are falling: $20, $18, $18, $15, $14 and $14. At the end of six months, you have invested $2400 and you own 148.24 shares. While the average price per share is $16.50, your average cost per share is only $16.19.
Investing $400 Each Month in a Falling Market |
Month
Bought |
Investment
|
Price
Per Share |
Shares
Purchased |
1 |
$400 |
$20 |
20.00 |
2 |
$400 |
$18 |
22.22 |
3 |
$400 |
$18 |
22.22 |
4 |
$400 |
$15 |
26.66 |
5 |
$400 |
$14 |
28.57 |
6 |
$400 |
$14 |
28.57 |
Totals: |
$2400 |
$16.50 (avg) |
148.24 |
Average cost per share: $16.19
(Total investment divided by number of shares bought) |
|
Average price per share: $16.50
(Sum of share price divided by the number of contribution) |
*This is a hypothetical example only and is not indicative of any performance for any particular investment.
Now, that may not seem like such good news considering the current price per share is $14. But, if you had invested the entire $2400 in the first month of your investing program, you would have fared worse. You would have purchased only 120 shares, and the value of your account at the end of the six-month period would be only $1680, $395.36 less than the current value under this scenario. With dollar cost averaging, you own more shares, and the average cost of each share is usually less than the average price per share. |
How Does Dollar Cost Averaging Work in a Rising Market? (Example*)
Once again, we’ll assume a monthly retirement investment of $400 for six months. This time, share prices are rising, and you buy shares at: $15, $17, $20, $20, $23 and $25. At the end of the six-month period, you own 123.58 shares and your average cost per share is $19.42 — 58 cents less than the average price per share ($20).
Investing $400 Each Month in a Rising Market |
Month
Bought |
Investment
|
Price
Per Share |
Shares
Purchased |
1 |
$400 |
$15 |
26.66 |
2 |
$400 |
$17 |
23.53 |
3 |
$400 |
$20 |
20.00 |
4 |
$400 |
$20 |
20.00 |
5 |
$400 |
$23 |
17.39 |
6 |
$400 |
$25 |
16.00 |
Totals: |
$2400 |
$20.00 (avg) |
123.58 |
Average cost per share: $19.42
(Total investment divided by number of shares bought) |
|
Average price per share: $20.00
(Sum of share price divided by the number of contributions) |
*This is a hypothetical example only and is not indicative of any performance for any particular investment.
With the benefit of hindsight, it would have been better to invest the entire $2400 during the beginning of the six month period when prices were at the lowest level. But, could you have predicted precisely when to invest? And, would you have known with absolute certainty that the investment would experience a steady rise during the next six months? Probably not. With dollar cost averaging, you may spread the risk of investing in a volatile market without worrying about the timing of your purchases. |
Choice and Portability
The investment options available for our pre-tax savings plans are fixed annuities, variable annuities, mutual funds and professionally managed investment portfolios. This variety enables you to develop a plan that suits your time horizon, risk tolerance and investment objectives. Also, your retirement account is portable. If you should leave your job, your account can be transferred to another employer's retirement program or rolled to an IRA.
Dynamic Asset Management
Most pre-tax savings retirement plan participants have access to professionally managed investment portfolios, with either insurance or mutual fund companies. In addition, Legend Advisory Corporation, a registered investment advisor, offers five diversified asset allocation portfolios through the Strategic Asset Management ® program. The portfolios are managed by a team of experienced investment professionals who monitor world markets in an effort to maximize potential returns and reduce risk.
Loan Provision
Loans are available from most §403(b), 457 and 401(k) plans. Under Legend’s loan program, both principal and interest are paid back to your account via automatic payroll deduction. Loans may affect cash values and death benefits*.
Distributions
Pre-tax savings account assets can be withdrawn without penalty after age 59½, even if you are still employed**. Upon withdrawal, ordinary income taxes will apply. Distributions must begin no later than April 1 of the calendar year following the calendar year in which you attain age 70½, unless you are still working. §403(b) plan participants who have terminated employment under the age of 55 may begin distributions through an IRS provision known as a §72(t) distribution.
The Benefits of Retirement Investing for Roth Account Holders [Top]
- Tax-free Growth Potential — Assets in Roth accounts may grow tax-free.
- Tax-free Retirement Income — Roth accounts can provide tax-free income during your retirement years, since all qualified distributions for a Roth §403(b) account is tax-free***.
- Dollar Cost Averaging & Payroll Deduction Plans (link to How Dollar Cost Averaging Works Section) — As with regular pre-tax payroll reduction accounts, employees may fund their Roth retirement plan accounts through payroll deduction. Since this amount is automatically deducted from your paycheck at regular intervals, dollar cost averaging is built in to your investment plan.
- Choice and Portability— The investment options available for Roth plans are fixed annuities, variable annuities, mutual funds and professionally managed investment portfolios. This variety enables you to develop an investment strategy that suits your time horizon, risk tolerance and investment objectives. Also, your Roth account is portable. If you should leave your job, your account can be transferred to another employer's Roth program or rolled to a Roth IRA.
- Dynamic Asset Management (link to same professional investment management page) - Most Roth account plan participants have access to professionally managed investment portfolios, with either insurance or mutual fund companies. In addition, Legend Advisory Corporation, a registered investment advisor, offers five diversified asset allocation portfolios through the Strategic Asset Management ® program. The portfolios are managed by a team of experienced investment professionals who monitor world markets in an effort to maximize potential returns and reduce risk.
- Loan Provision — Loans are available from most Roth §403(b) plans. Under Legend’s loan program, both principal and interest are paid back to your account via automatic payroll deduction. Loans may affect cash values and death benefits*.
- Distributions — Roth distributions may begin at age 59½ (provided the account has been funded for at least five years). And, while regular pre-tax account distributions are mandatory at age 70½, Roth retirement account distributions are not mandatory until death if the account is rolled over to a Roth IRA.
*Defaulting on a loan from a retirement plan constitutes a distribution from that plan. Distributions from a retirement plan are subject to federal income tax and may incur an additional 10% penalty if the participant is under age 5 9 ½ .
**A 10% penalty may apply for early withdrawals from a §403(b) account, i.e. before age 59 ½, unless taking advantage of a §72(t) distribution.
***In order for the Roth §403(b) account to be distributed tax-free, it must be funded for a minimum of five years and distributions cannot be taken before the accountholder attains age 59½. A participant would also qualify for tax-free distributions if the account was held for five years and the account owner became disabled (under the strict definition of disability of §72(p) of the IRS code). Furthermore, in the event of the accountholder’s death, beneficiaries would receive tax-free distributions if the account was held for at least five years. Otherwise, the distribution would be treated as part return of principal and part taxable earnings. A 10% premature withdrawal penalty may apply to the earnings.
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*All Quotes 30 Min Delay
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