Don't Fall Behind in Saving for Retirement

Article Highlights:

• Predicting Social Security Income 
• Planning for the Future 
• Employer Retirement Plans 
• Tax Incentive Retirement Savings Plans

Some folks have been tapping or suspending their retirement savings to make ends meet during this COVID-19 pandemic, and although understandable, it is important that they continue making contributions to their savings as quickly as financially possible.

Still other people have simply been ignoring the need to save for their retirement, which can have an unpleasant result when it comes time to retire. That tends to be the case with younger individuals who perceive retirement to be far in the future and therefore believe they have plenty of time to save for it. Some will postpone the issue until late in life and then must scramble during their last few working years to fund their retirement. Other people ignore the issue altogether, thinking their Social Security income (assuming they qualify for it) will take care of their retirement needs.

By current government standards, a single individual with $12,490 or a married couple with $16,910 of annual household income is at the 100% poverty level. If you compare those levels with potential Social Security benefits, you may find that expecting to retire on just Social Security income may result in a bleak retirement.

You can predict your future Social Security income by visiting the Social Security Administration’s Retirement Estimator. With the Retirement Estimator, you can plug in some basic information to get an instant, personalized estimate of your future benefits. Different life choices can alter the course of your future, so try out different scenarios – such as higher and lower future earnings amounts and various retirement dates – to get a good idea of how these scenarios can change your future benefit amounts. Once you’ve done this, consider what your retirement would be like with only Social Security income.

If you are fortunate enough to have an employer-, union-, or government-funded retirement plan, determine how much you can expect to receive when you retire. Add that amount to any Social Security benefits you are entitled to and then consider what retirement would be like with that combined income. If this result portends an austere retirement, know that you will be better off the sooner you start saving for retirement.

With today’s low interest rates and up-and-down stock market, it is much more difficult to grow a retirement plan with earnings than it was 10 or 20 years ago. With current interest rates not even, or just barely, covering inflation rates, there is little or no effective growth. That means one must set aside more of one’s current earnings to prepare for a comfortable retirement.

Because the government wants you to save and prepare for your own retirement, tax laws offer a variety of tax incentives for retirement savings plans, both for wage earners and for self-employed individuals and their employees. These plans include the following:

• Traditional IRA – This plan allows up to $6,000 (or $7,000 for individuals aged 50 and over) of tax-deductible contributions each year. In the past, you could no longer make contributions after reaching age 70½. However, beginning in 2020 and for future years, contributions can be made at any age as long as you have work earnings for the year that the contribution applies. The amount that can be deducted phases out for higher-income taxpayers who also have retirement plans through their employers. 
  
  
• Roth IRA – This plan also allows up to $6,000 (or $7,000 for individuals aged 50 and over) of nondeductible contributions each year. The amount that can be contributed phases out for higher-income taxpayers; unlike the Traditional IRA, these amounts phase out even for those who do not have an employer-related retirement plan. Note the difference: the phaseout applies to the deductible amount for Traditional IRAs, whereas the contribution amount phases out for Roth IRAs. 
  
  
• Spousal IRAs – Spouses with no compensation for the year may contribute to their own IRA based upon their spouse’s compensation. If the unemployed spouse chooses a traditional IRA and the working spouse participates in an employer’s plan, the contribution’s deductibility phases out when adjusted gross income is between $196,000 and $206,000; if a Roth IRA is chosen, the contribution limit also phases out between $196,000 and $206,000, even if the working spouse isn’t covered by an employer’s plan 
  
  
• Employer 401(k) Plans – An employer’s 401(k) plan generally enables employees to contribute up to $19,500 per year, before taxes. In addition, taxpayers who are age 50 and over can contribute an extra $6,500 annually, for a total of $26,000. Many employers also match a percentage of the employee’s contribution, and this can amount to a significant sum for those who stay in the plan for many years. 
  
  
• Health Savings Accounts – Although established to help individuals with high-deductible health insurance plans pay their medical expenses, these accounts can also be used as supplemental retirement plans if an individual has already maxed out his or her contributions to other types of plans. Annual contributions for these plans can be as much as $3,550 for individuals and $7,100 for families. 
  
  
• Tax Sheltered Annuities – These retirement accounts are for employees of public schools and certain tax-exempt organizations; they enable employees to make annual tax-deferred contributions of up to $19,500 (or $26,000 for those aged 50 and over). 
  
  
• Self-Employed Retirement Plans – These plans, also referred to as Keogh plans, allow self-employed individuals to contribute 25% of their net business profits to their retirement plans. The contributions are pre-tax (which means that they reduce the individual’s taxable net profits), so the actual amount that can be contributed is 20% of the net profits. 
  
  
• Simplified Employee Pension Plan (SEP) – These are plans that are relatively easy for a self-employed individual to set up and can be established in the following year up to the due date of the tax return, including the extended due date if an extension is filed. They are quite commonly used by self-employed individuals without employees and may also be used by self-employed individuals who are willing to make contributions on behalf of their employees. The contribution limit for the self-employed individual is the lesser of 25% of their compensation (which equates to 20% of the net profits from self-employment, after deducting the SEP contribution) or $57,000 for 2020. Contributions made on behalf of employees are deductible as a business expense, while the contributions for the self-employed individual are deducted as an above-the-line deduction on the individual’s income tax return.

Multiple Plan Limitations – If individuals wish to maximize their retirement contributions, they may become involved in more than one plan and end up with a combination of plans. This is where some overall limitations apply and where individuals can unknowingly make excess contributions, resulting in penalties and requirements to make corrective distributions.

• 401(k)s – It is not uncommon for individuals to have multiple employers, each with a 401(k) plan. This can possibly create a situation in which the employee makes an excess elective-deferred compensation contribution. The annual maximum limit applies to all 401(k) contributions combined.
   
• Combinations of Deferred Income Plans – There is also a $57,000 limit for 2020 on the aggregate amount of all elective deferrals made by an individual during the year. Plans affected by this limit include the following:
  
  
  o 401(k) plans,
  o SEP plans,
  o SIMPLE plans, and
  o Tax-sheltered annuities (TSAs, also referred to as 403(b) plans)
  
  However, Code Sec. 457 plans (government plans) are not included in the overall deferral limitations 
  
  
• IRAs – The IRA limits apply to the aggregate contributions to traditional and Roth IRAs. However, an individual can have both an IRA and deferred income plans.

Saver’s Credit – To help lower-income taxpayers save for retirement, Congress several years ago included a provision in the tax law that allows a 10%, 20%, or 50% tax credit on up to $2,000 of retirement plan and IRA contributions per year. The percentage of the credit depends on the taxpayer’s filing status and income (when the income is lower, the percentage is higher). For 2020, the maximum AGI at which a credit can be claimed is $64,000 for taxpayers filing a joint return, $48,000 for head-of-household filers, and $32,000 for all other filing statuses. For example, a single individual with an income of $30,000, who made an IRA contribution of $2,000 in 2020, would be eligible for a Saver’s Credit of $400 ($2,000 x 20%). Thus, their $2,000 IRA contribution would actually cost them only $1,600.

Qualified 2020 Distributions – For 2020, the Congress did provide relief from the early 10% distribution penalty on up to $100,000 for distributions from IRAs and qualified retirement plans. Individuals who qualify for these distributions include the following:

• Those diagnosed with the virus SARS-CoV-2 or coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention, 
  
  
• A spouse or dependent who is diagnosed with such virus or disease by such a test, or 
  
  
• An individual (or the individual’s spouse or household member) that experiences adverse financial consequences as a result of being quarantined, being furloughed/laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care resulting from such virus or disease, or closing or reducing hours of a business owned or operated by the individual due to such virus or disease.

If you were eligible and took a distribution, you can either include the income all in 2020 or include one-third in each of the years 2020, 2021, and 2022. You also have the option to return the distribution to your retirement plan or IRA and restore your retirement savings. The recontribution would need to be made within three years of the date of the distribution. You don’t have to return all of the distribution, but what you can return will certainly help your retirement savings. Plus, the IRS will refund the taxes you paid on the amount you returned to your retirement plan.

Each individual’s financial resources, family obligations, health, life expectancy, and retirement expectations will vary greatly, and there is no one-size-fits-all retirement savings strategy for everyone. Purchasing a home and putting children through college are exemplary events that can limit an individual’s or family’s ability to make retirement contributions; these events must be accounted for in any retirement planning.

If you have questions about any of the retirement vehicles discussed above, please give this office a call.

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