Retirement Account Overview
Banking Law on June 12, 2012
With traditional pensions for Americans steadily becoming more of an exception than the rule, it is all the more important to become familiar with the other “self-directed” retirement savings vehicles that are available. From a tax standpoint, there are two kinds of plans: those that are tax-deferred and those that are after-tax.
Tax-deferred plans, such as Individual Retirement Accounts (IRAs) and employer-sponsored 401(k)s, have the advantage of allowing taxable income to be reduced by the contributions each year, and growth of the account through appreciation and interest or dividends is tax-deferred. Of course, at some point in the future those taxes must be paid. Withdrawals after age 591/2 are taxed as ordinary income, and a “required minimum distribution” must occur at age 701/2. Tax-deferred accounts make the most sense for those who anticipate that their income tax rate will be lower in retirement than while working.
After-tax plans, like Roth IRAs and employer-sponsored Roth 401(k)s, are funded with contributions using after-tax dollars. If certain conditions are met, the retiree will not have to pay income tax on withdrawals, so the account will have grown tax-free. Unlike with tax-deferred plans, there is no mandatory distribution requirement at age 701/2, giving more flexibility in estate planning. After-tax accounts usually appeal to those expecting to be in a higher tax bracket in retirement than while working.
A “self-directed” plan, of course, means that it is up to the accountholder, perhaps with the help of a financial advisor, to select the investments used for funds in the account.
There is no one-size-fits-all approach to this, but conventional wisdom is that there should be diversity among types of investments and that as someone approaches retirement, the mix of investments should move from growth-oriented investments carrying greater risk, such as stocks, to more conservative income-producing investments, such as bonds or certificates of deposit.
A measure of protection can be obtained by placing funds earmarked for retirement in certificates of deposit or other interest-bearing accounts at FDIC-insured institutions. There will be deposit insurance coverage up to $250,000 for the combined balance of all self-directed retirement accounts owned by the same individual in the same insured institution.