Accounting Traditional IRAs and SEPs

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Traditional IRAs and SEPs
An indepth look at funding a Traditional IRA, as well as a SEP for the self employed person

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Individuals: Traditional IRA's

Changing Jobs? Roll That 401(k) over to an IRA.

As the average time a person spends with a particular employer continues to decline, the need for more individuals to retrieve money from employer retirement accounts (such as a 401(k)) increases.

Often we hear about cases where a person has 20% of their total retirement plan account balance withheld for income taxes from their distribution check. And of course there is the dreaded 10% penalty for early withdrawal from retirement plans that can be tacked on when filing annual income tax returns. Of course, all this can be avoided by simply setting up a Traditional Individual Retirement Account (IRA) with a financial advisor. An advisor will even help you to fill out the proper paperwork, which can request a "Direct Rollover" of your funds.

By choosing the "Direct Rollover" method, funds go directly from your employer to your IRA without any money being withheld from your distribution. The whole transaction is tax-free, allowing you to get on with saving for the future.

Making that 2003 Traditional IRA Contribution

Once your traditional IRA is established, you should start making your 2004 contributions immediately. Make sure you pay yourself first and send in $250 per month ($290 if you are over age 50 as of December 31, 2003), as most financial advisors will tell you that "dollar cost averaging" is the best way to invest. By next year you will have already maximized your 2004 contribution, and won't have to scramble to come up with the entire $3,000 ($3,500 for those who are at least 50 years old).

While you're thinking about your IRA, don't forget to make your 2003 Traditional IRA contribution. The funding can be done up until April 15, 2004, as can the establishment of the account itself.

The Future of Traditional IRA Contributions

For tax years from 2005 through 2007 the maximum contribution to a Traditional IRA will be $4,000 ($5,000 for taxpayers who are 50 years old or more during the tax year).

For 2008 the maximum contribution to a Traditional IRA will be $5,000 ($6,000 for taxpayers who are 50 years old or more during the tax year).

Starting in 2009 the maximum contribution to a Traditional IRA will be subject to an annual inflation adjustment.

Non-Working Spouse

A non-working spouse may make a Traditional IRA contribution for 2003 even if the working spouse is an active participant in an employer-sponsored retirement plan. This contribution may be the maximum of $3,000 ($3,500 if 50 or older), but this opportunity phases out for taxpayers whose adjusted gross income ranges between $150,000 and $160,000.

Early Distributions From Your IRA

Taxpayers typically cannot receive distributions from a Traditional IRA until they reach age 59 and a half. Distributions taken prior to attaining that age will incur a 10% penalty for the early distribution. However, the following exceptions apply:

Distributions due to total disability

Distributions of substantially equal payments (early retirement)

Distributions for deductible medical expenses or health insurance premiums.

First time homebuyers up to $10,000.

Business Owners: A SEP may be for you

Some might say that a Simplified Employee Pension (SEP) is a glorified IRA. Although it often acts like one, it doesn't when it comes to socking away money for the future.

Often in a new business start up, the entrepreneur will start out without employees. Once a business owner hires employees, any company-provided retirement plan needs to take into consideration all eligible employees. So if the business owner wants to sock away 25% of his compensation into a tax deferred retirement plan, the same percentage also needs to be contributed on behalf of all staff. That can be a costly venture, often too expensive for young, growing companies. It can often leave the business owner with the impression that the only way to save for the future is through methods that do not provide tax benefits.

In the past, business owners who have no employees could contribute 25% of their compensation. For a start-up business, maximizing a contribution was possible but would often be an amount comparable to that of an IRA contribution. Only a business owner with earnings in excess of $160,000 for the year could make a contribution as much as $40,000.

But now that has all changed with the relaxation of retirement plan rules. Now a business owner can contribute as high a percentage of their earnings as they like up to $40,000 as long as there aren't any other employees.

Although this is excellent news, many new business owners are either hesitant or not in a stable enough position to contribute a high percentage of their earnings. They should, however, give it serious consideration. If they know that they won't be hiring staff for another couple of years, they should consider making a few large payments now. For instance, if you plan to contribute $40,000 over the next four years, instead of doing it evenly over that time period, put away $20,000 in each of the first two years. You will have saved the money you wanted, but will not have to make any contribution on the behalf of your staff. In the long run, it could save thousands of dollars.