Law in the Marketplace: Retirement plans

As I’ve mentioned previously in this column, the era of generous retirement plans provided by employers to their employees is, for most of us, a thing of the past. However, starting a few decades ago, the federal government has attempted to address this gap with:

Many kinds of tax-favored “qualified plans” such as 401(k)s and plans similar to those) plans; and

Tax-favored Individual Retirement Accounts (“IRAs”) .

In this column, I’ll refer collectively to all of these many types of plans simply as “Plans.” For the reasons indicated below, if you aren’t already participating in a Plan, it’s very possible you should.

The above Plans are “tax-favored” because, with certain exceptions:

Contributions you make to them in Plan trusts are deductible from your federal taxable income;

The growth of these contributions in these trusts is tax-free; and

Although your withdrawals of these funds (called “distributions” in the Plan world) are taxable, you’ll probably want to make them after you’ve retired, when your federal income tax rate is likely to be much lower than your pre-retirement rate.

Choosing the best Plan can be difficult; to make this choice wisely, you may well require expert help. I have a basic knowledge about Plans, but I don’t advise about them. But if you’d like, I can refer you to a Plan expert if you think that will be useful to you. In the meantime, below is a list of the main types of Plans and, very briefly, some of the pros and cons of each that may be relevant to you. In future columns I’ll discuss some of these Plans in greater detail.

“Qualified plans” are Plans that comply with the federal tax rules imposed under Internal Revenue Code section 401. There are seven main types of Section 401 qualified plans, and there are similar plans under other IRC provisions. The rules governing who can participate in these Plans, the amounts that participants can contribute to them deductibly, participants’ distributions from them and other rules governing their operation are complex, and the initial and ongoing costs of establishing and operating them can be substantial. However, for employees of larger companies (e.g., those with more than 100 employees) and even for a few smaller companies and sole proprietors, they can yield better federal tax benefits than IRAs.

There are three main kinds of IRAs — namely, (i) “basic” IRAs, (sometimes referred to as “traditional” or “contributory” IRAs); (ii) SEP-IRAs (i.e., “Simplified Employee Retirement Plans”), and (iii) SIMPLE IRAs (i.e., “Savings Incentive Match Plans for Employees”). You can readily and inexpensively establish any of these IRAs through your bank or another financial institution. With certain exceptions, you can make deductible contributions to IRAS in 2022,as follows: (i) to a basic IRA, $6,000 a year; (ii) to a SIMPLE IRA, $14,000; (iii) to a SEP-IRA, the lesser of $61,000 or 25% of your 2022 compensation.

Thus, for many readers of this column who are sole proprietors and for some who have a small number of employees, by far the best Plan to establish and contribute will often be a SEP-IRA.

However, while you cannot deduct your contributions to any of the various types of federal retirement Plan called “Roth” Plans, you can withdraw your contributions to these plans tax-free, and Roth Plans also have certain other advantages over non-Roth Plans.

A link to a website that provides an excellent overview of both qualified and IRA Plans is: https://www.investopedia.com/ask/answers/102714/what-are-main-differences-between-simplified-employee-pension-sep-ira-and-simple-ira.asp. This website will also give you links to the IRS websites that explain the various types of Plans.

John Cunningham is a lawyer licensed to practice law in New Hampshire and Massachusetts. He is of counsel to the law firm of McLane Middleton, P.A. Contact him at 856-7172 or lawjmc@comcast.net. His website is llc199a.com. For access to all of his Law in the Marketplace columns, visit concordmonitor.com.

Law in the Marketplace is a legal advice column. It runs every week in the Sunday Business section. The author is a lawyer in Concord and not a member of the Monitor’s staff.

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