Retirement Planning – IRA and 401k Rules, 401k Loans, and Limits

As with a lot of people, I am currently debating how I should invest my retirement funds. However, to get the best from either, it is important to understand both the IRA and 401k rules as they apply to retirement planning.

First of all, I have considered the company 401k plan. This is, in essence, very similar to the Traditional Individual Retirement Accounts (IRA) – which will be covered a little further on – certainly with regards to tax limitations and so on. All contributions are invested, before the withdrawal of taxes. Subsequently, the Adjusted Gross Income, (AGI) is lowered, allowing a tax break immediately. The invested money will not be taxable until it is withdrawn upon retirement. It is possible to withdraw the investment early, but there are restrictive penalties for this. 401k loans can be made, but there are certain things that must evaluated.

The annual contribution is limited each tax year. Currently for 2009, this is set at $16,500. In 2008 it was limited to $15,500. The limit for 2010 will be announced by the IRS in October of this year, and new 401k rules dictate this will be linked to inflation. There are also additional contribution rules for the over 50s, where an additional $5,500 is allowed to be invested, over and above the previously given limits.

One major benefit to take advantage of with 401k rules is the potential company match offered. This allows the employer to match a defined percentage contribution of the employee’s total salary. Percentages vary, and are decided internally, but whatever this limit is set at, results in free cash to the fund. Also, 401k Loans are available, which are not available for IRA counterparts.

So next, I looked at the IRA rules, and how these best suit me. There are two types of IRA: Traditional and Roth.

As with the Company 401k plan, traditional IRA money is invested with the benefit of tax deduction, thus lowering the AGI and giving an immediate tax break. But again, the stiff penalties for early withdrawal and taxable when withdrawing need to be carefully considered.

With a Roth IRA or the Roth 401k, taxes are not tax deductible. This of course appeals, as no taxes are due upon retirement. However, as with the traditional plan and the 401k rules, stiff penalties will be imposed if taking early withdrawal.

A major difference that both IRA and 401k rules dictate is the inability for a company match, due to their being individual investment plans. Limits for both IRAs also differ according to age. Currently, the limit is $5000 for the under 50s, and $6000 above this. Again, limits are announced in October, and are now to be linked to inflation rates.

The IRA & 401k rules given here are just the basics, and are indicative of a common thought process. Before deciding which plan to run with yourself, it is highly recommended that you spend some time with an Independent Financial Advisor, or other qualified professional, to best understand your personal circumstances. Despite the global uncertainty, investment is always going to remain the best policy for money throughout retirement.