Increased 2009 401k Contribution Limits

January 14, 2009

In developing a plan for my 2009 goals, I stumbled upon some changes to the 401k contribution limits in 2009. I currently don’t participate in my company’s 401k, but I set up a Vanguard Individual 401k for my self-employed income. Depending on my level of self-employed income in 2009, the following changes may affect my maximum contribution amount.

2009 401k Contribution Limits

The 2009 salary deferral contribution is limited to $16,500 if you’re under 50. If you’re over 50, the 2009 salary deferral contribution is limited to $22,000 ($16,5000 plus a $5,500 catch-up contribution). This results in a $1,000 increase in the salary deferral contribution and a $500 increase in the catch-up contribution when compared to 2008.

Total contribution limits also increased for 2009. If you’re under 50, total annual contributions (salary deferrals and employer contributions) max out at $49,000, which is increased from $46,000 for 2008. If you’re over 50, total annual contributions max out at $54,500, which is increased from $51,000 for 2008.

Individual 401k Maximum Contribution Limit

My Individual 401k maximum contribution limit is roughly calculated in the following way (for a sole proprietor under the age of 50):

  • If you’re net income is less than the salary deferral contribution limit ($16,500 for 2009) you may contribute your entire income reduced by 1/2 of your self-employment tax.
  • If your net income is greater than the salary deferral contribution limit, you must calculate your net compensation.
  • Net compensation is net profit from IRS Form 1040 Schedule C with 1/2 of your self-employment tax removed.
  • As a sole proprietor, you may contribute up to 20% of your net compensation in addition to the salary deferral contribution with a maximum value of $49,000 in 2009.

A plan contribution calculator from Vanguard can be found HERE.

Conclusion

Although I doubt I will earn enough self-employed income to reach the salary deferral limit, it’s always good to know what the limit is so you can plan accordingly. Between maxing my Individual 401k and my Roth IRA contributions, I have a lot of work ahead of me for 2009.

For another resource on the new 2009 401k contribution limits:

Increased 401k Contribution Limits in 2009 by Cash Money Life.

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2009 IRA Contribution Limits

January 13, 2009

I just published my goals for 2009. One of which is to max out my Roth IRA. The best way to achieve any goal is to plan. In doing my planning I had to look up the contribution rules and limits for 2009 to see if there were any changes from 2008’s contribution limits. The 2009 IRA contribution limits are as follows.

Traditional IRA Contribution Limits

The contribution limits did not change for 2009 as you can contribute up to $5,000. If you will be 50 years old by December 31, 2009 your contribution limit is $6,000. As a married couple, the contribution limits are effectively $10,000 and $12,000 as both you and your spouse are eligible for a traditional IRA.

Traditional IRA contributions have no income limitations, however, there are income limitations for deducting the value of the contribution.

Traditional IRA Deduction Limits

Deduction limits only apply if you are covered by an employer retirement plan. These deduction limits have not changed in 2009. If you’re unmarried, your contribution deductibility begins to phase out if your adjusted gross income (AGI) exceeds $53,000 and completely phases out at $63,000. If you’re married and both you and your spouse is covered by an employer retirement plan, your contribution deductibility begins to phase out if your joint AGI exceeds $85,000 and completely phases out at $105,000.

It gets slightly complicated if only one spouse is covered by an employer retirement plan. For the covered spouse, the contribution deductibility begins to phase out if your joint AGI exceeds $85,000 and completely phases out at $105,000. For the non-covered spouse, the contribution deductibility begins to phase out if your joint AGI exceeds $159,000 and completely phases out at $169,000.

Roth IRA Contribution Limits

The contribution limit for a Roth IRA also did not change and is $5,000. If you will be 50 years old by December 31, 2009 your contribution limit is $6,000. As a married couple, the contribution limits are effectively $10,000 and $12,000 as both you and your spouse are eligible for a traditional IRA.

As opposed to the traditional IRA, the Roth IRA has income limitations for contributions. The income limitations have changed for 2009 so take note. For unmarried individuals, the contribution limit begins to phase out with an AGI of $105,000 and completely phases out at $120,000. For married individuals, the contribution limit begins to phase out with a joint AGI of $166,000 and completely phases out at $176,000.

Conclusion

Even though 2008 is officially in the books, you can still contribute to a 2008 IRA up until the tax filing deadline of April 15. After 2009, the IRA contribution limits will be indexed to inflation, which will make IRAs very powerful investment vehicles.

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New Vanguard Individual 401k For Self-Employed Retirement Savings

November 11, 2008

Previously I blogged about the different self-employed retirement accounts and the different options for opening a solo/individual/self-employed 401k. I’ve been waiting for Vanguard to unveil an individual 401k to begin investing my self-employed income in a retirement plan. I originally heard rumblings of Vanguard launching it’s first individual 401k at the beginning of November. Today was the first day I was able to find any information on Vanguard’s website. I’m pretty excited about opening a Vanguard individual 401k and will do my best to detail the account details and benefits below.

Eligibility

Individual 401ks are available for self-employed individuals such as, sole proprietors and LLCs. This retirement plan will cover the plan administrator, partners and the spouse of the business owner. This plan does not cover individuals with common-law employees such as children. There are also no age and service requirements.

Contributions

Plan administrators set-up an individual 401k plan and administer the plan through Vanguard Small Business Online. There are three types of contributions allowed: employee salary deferral contributions, Roth salary deferral contributions and employer contributions. This means Vanguard offers a Roth individual 401k for those who prefer to invest after-tax money. The Roth individual 401k does not have income restrictions like a Roth IRA. Total contributions for a fiscal year are $46,000 or $51,000 with catch up contributions.

Sole proprietors may contribute up to 20% of net compensation. I am able to defer up to $15,500 as my employee contribution and up to an additional 20% of my net compensation. I will be able to contribute nearly 100% of my self-employed income. I am still on the hook for one half of the self-employment tax.

Investment Options

The investment options are the reason why I have waited patiently for Vanguard to launch an individual 401k. There are over 70 Vanguard funds available for retirement investing. None of these funds have sales commissions. Vanguard is notorious for delivering mutual funds with minimal expense ratios. They also provide target retirement funds and LifeStrategy funds. Target retirement funds automatically move funds from stocks to bonds as you get closer to retirement. LifeStrategy funds vary the ratio of stocks to bonds to cash reserves depending on how aggressive you want to be and how far away your savings goal is.

Account Management

Employers will be able to manage the retirement plan through Vanguard Small Business Online. Employers will be allowed to make contributions, review the transaction history and download forms via this online interface. Employees will have access to account balances and planning tools.

Plan Administrator

A plan administrator must be designated for an individual 401k who must maintain records and submit reports (including Form 5500 when income exceeds a certain level). As a sole proprietor I would be the plan administrator, however, they recommend a co-plan administrator to act in the absence of the plan administrator.

Fees

Vanguard will not be charging an account initiation fee to the employer and there is no minimum investment to open the account. Some funds do have minimum initial investments. Vanguard mutual funds average expense ratios of 0.20%, which is always applied. An account service fee of $20 is required per year for each Vanguard fund in the account. The account service fee is waived when you become a Voyager member (total account assets of $100,000). Only two Vanguard funds charge purchase fees, however, a slightly larger number charge redemption fees if you remove funds within a certain time period.

Distributions

For individual 401ks, the standard distribution penalties and rules apply. If you are under 59.5, you will be subject to taxes and IRS penalties unless you meet certain restrictions. If you are between the ages of 59.5 and 70.5 you are only subject to income taxes. If you are over 70.5 the IRS requires minimum withdrawal distributions. For Roth individual 401ks, the standard distribution penalties and rules apply. If you are under 59.5 years of age or it has been less than 5 years since the first contribution, your money may be subject to income taxes and penalties. If you are over 59.5 years of age, distributions are tax free. At age 70.5, the required minimum distribution kicks in.

Now What

I have to set up my individual 401k by December 31st in order to participate for fiscal year 2008. I still have until the income tax filing date to fund the account for 2008. The website has a link to request a Vanguard individual 401k New Account Application either online or by mail. The link currently is not working. I will call the small business unit of Vanguard tomorrow to request an account application as I have been waiting for awhile to open this account and would like to get the ball rolling so I don’t miss the December 31st deadline.

In my opinion Vanguard is the best place to keep your retirement accounts. I already have my Roth IRA with Vanguard and am thoroughly enjoying the bare bones expense ratios. I’m currently reading Bogle’s book on mutual funds, which hammers home the point of keeping all costs to a minimum, and he certainly follows through on that at Vanguard. I will keep you all updated when I have more information regarding the application process.

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How Obama Might Affect Your Taxes And Personal Finances

November 6, 2008

Barack Obama was voted the new president elect yesterday. Very early in the campaign, the number one issue changed from the war in Iraq to the slumping economy. Obama has preached change throughout his campaign and the most pressing issue that requires change is the economy. Additionally, Democrats hold the majority in both houses of Congress and in combination with Obama will quickly try to turn the economy around in ways that may affect your mortgage, taxes and retirement plans.

Retirement Plans

Obama has entertained the idea of temporarily eliminating the annual required minimum distributions from IRAs if you are 70 or older. The idea is that you shouldn’t be forced to sell losing investments if you don’t need the income. Obama has also mentioned making the required withdrawals tax free for a short time.

He has proposed temporarily removing early withdrawal penalties on $10,000 of savings from 401ks and IRAs. The money would still be subject to federal and state income taxes.

A more permanent proposal may include matching 50% on the dollar for the first $1,000 of retirement contributions if your income is less than $75,000. I am all for any proposal that encourages retirement savings. He has also proposed requiring employers to set up automatic contributions to IRAs (if a 401k or similar retirement plan is not offered) for employees. The employees would then have the option to opt out. I have read that more employees participate in retirement savings programs if they are automatically enrolled and have to opt out.

2nd Stimulus

Prior to the major bailout plan, Obama proposed a 2nd stimulus plan, which would result in roughly $500 stimulus checks for individuals and $1,000 for families. The stimulus plan would also encompass help for small businesses and failing mortgages.

Tax Plan

Obama has proposed reinstating the 36% and 39.6% tax rates for individuals with income of $200,000 and joint filers with income of $250,000. He plans on keeping all other income tax rates the same as the Bush levels. Obama plans a similar tax increase for capital gains rates. He plans on increasing the top capital gains tax rate to 20%.

Obama’s plan does include tax cuts in a few areas for lower level income filers. He wants to eliminate income taxes for low income seniors. He wants to add or increase tax credits for Social Security taxes, college expenses and mortgages who don’t itemize. Obama has also mentioned offering a refund from taxes levied on oil companies, although with the gas prices on the decline, I don’t know how much steam this refund will gain.

Mortgages and Foreclosures

Obama has proposed including a 90-day moratorium on foreclosures for firms receiving help from the $700 bailout plan. This plan includes the ability to buy troubled mortgages and restructure them. Obama also favors providing bankruptcy judges the power to write down mortgage debt. There is an argument that allowing judges to modify loans could lead to higher mortgage rates for future home buyers.

Conclusion

The next year will be extremely interesting. While doing research on Obama’s website, I browsed through all of his ideas for creating jobs, improving infrastructure, furthering energy independence, etc. and I just don’t see how he can not raise taxes. All of these ideas for change and tax cuts sound wonderful. I’m all for energy independence and promoting research and science jobs, but I just don’t see it happening without increasing taxes. Even though I don’t know how Obama will make it happen, I suppose I’m willing to see what he can do. Anybody else have thoughts as to how Obama’s tax plans and economy rescue plans will affect main street?

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10 Steps to Retire a Millionaire

October 22, 2008

As I was checking the damage for the day from the stock market, I stumbled upon an interesting article detailing 10 steps to retire a millionaire. The ten steps provide a good outline for retiring as a millionaire, which is something I would love to do sooner rather than later. The steps are as follows:

  1. Set the goal
  2. Start saving
  3. Get aggressive
  4. Prepare for rainy days
  5. Save more
  6. Watch your spending
  7. Monitor your portfolio
  8. Max out your options
  9. Catch-up contributions
  10. Have patience

Set the Goal

Setting a goal is the first step towards accumulating a million dollar nest egg. Just like you can’t run before you walk, you can’t successfully retire with a million dollars if you do not make it a goal. From my cross-country experiences, my best seasons came when I set realistic goals and then worked hard to achieve them.

Start Saving

Half of the battle is starting. If you don’t start saving, you will not have money to invest. If you don’t invest, you will miss out on a huge portion of your possible nest egg. Due to the power of compounding, most of your retirement money will come from interest. Don’t be afraid to start with as little as $25 a month. You have to start somewhere.

Get Aggressive

This step refers to the fact that keeping money in a savings account or in bonds will not generate large enough returns to achieve the goal of retiring a millionaire. Investing in stocks, both foreign and domestic. Diversify your portfolio with riskier small cap stocks and emerging market funds.

Prepare for Rainy Days

An emergency fund is crucial for accumulating savings. High interest debt will erode your savings and severely diminish your overall returns. Emergency funds provide a cushion in case a rainy day emerges.

Save More

Do not be content with your current saving pace. When you make more money, save more money. If you want to save more, try to find other ways to supplement your income. Take up some self-employed work like tutoring kids in your area of expertise. Who knows, you may even stumble upon a successful and satisfying full-time line of work.

Watch Your Spending

Watching you spending goes along with saving more. If you spend less, there is more to save. Creating a budget is a great way to track spending and reduce unnecessary spending.

Monitor Your Portfolio

Rebalance your portfolio to maintain an acceptable level of risk. From everything I have read it is a good idea to rebalance your portfolio every year or two. It prevents your portfolio from becoming too risky and forces you to sell high and buy low.

Max Out Your Options

The best options to grow a nest egg are in tax advantaged accounts like IRAs and 401k’s. If your savings allow it, maximize your contributions to your tax advantaged accounts and if there is any money left over dump it into taxable accounts. If utilizing taxable accounts is a reality for you, make sure you invest the correct funds in the correct accounts. For example, bonds that are exempt from federal and state taxes should not be kept in tax advantaged accounts.

Catch-Up Contributions

After surpassing the golden age of 50, contribution limits increase. Take advantage and continue maximizing your tax advantaged accounts.

Have Patience

Becoming a millionaire does not happen over night. Most of us will not win the lottery. A lot of us will never make $100,000 in a year. A million dollars sounds like a lot of money and it is. The only way to achieve this goal is to invest as much as you can as early as you can. Compounding is your best friend and time can be your worst enemy.

Overall, the best advice I can give you regarding saving towards retirement is to start as early as possible. Let time be your friend and not your enemy.

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Maximizing Roth IRA Contributions

September 18, 2008

Once I have completed the down payment on my condo and finished furnishing it, I will direct my savings towards maximizing my roth IRA and a solo 401k. I decided to open a roth IRA instead of a traditional IRA because I wanted to diversify the tax-sheltered retirement accounts. My solo 401k will be funded with pre-tax money, while a roth IRA is funded with post-tax money. Fortunately my AGI is below the contribution limit level for 2008, which is $101,000 so I am eligible to invest $5,000 into my roth IRA. For those of you less fortunate to be making such a large salary, there is a way to invest in a roth IRA for the future.

Contribute to a Roth IRA Even Though You Don’t Qualify

First, you have to open a nondeductible traditional IRA. Everybody qualifies for a nondeductible traditional IRA. In 2010, income limits for converting a traditional IRA into a roth IRA no longer apply. Once the income limits no longer apply you transfer your traditional IRA to a roth IRA. Since you funded your traditional IRA with post-tax money the conversion costs are minimal. The only cost is the taxes on income earned from your investments between now and 2010.

Let’s take this scenario one step further. Most CDs that I have invested in paid out interest monthly. Suppose you invest in a CD that only pays out interest when the CD matures. If the maturation date is after January of 2010 when you convert to a roth IRA, there is no cost associated with converting since there has been no income. Obviously, a CD such as this will provide a lower return as the interest will not be compounding. Before deciding to follow this route, you must investigate how much you save in taxes on the interest versus how much interest you are losing by not compounding.

Maximizing Investments on IRA Contributions

All funds have some sort of annual fee associated with them. At the very least there is an annual expense ratio. When you fund your IRA or 401k, most everybody allows the broker to take the annual fees out of the contribution. When this happens you’re not maximizing your contributions or your deductions. If you send in a separate check that covers your annual fees, the full $5,000 of contributions is invested in your retirement account. In addition, the check you sent for annual fees can be deducted as an investment expense.

If your goal is to maximize your retirement contributions make sure you are truly maximizing your retirement contributions. The tax laws can be confusing, but if understood you can retire much earlier, which is my long-term goal.

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IRA Contribution Rules and Limits for 2008

September 2, 2008

I have previously written about retirement accounts for self-employed individuals. Another option for retirement saving is the Individual Retirement Account (IRA), which is available for any individual. IRAs are gaining steam as a powerful retirement account after some favorable changes to the tax law. Up until a few years ago IRA contributions were limited to $2,000 and had severe income limitations. There are two types of IRAs, traditional and roth. At a very basic level, a traditional IRA is funded with before-tax dollars and a roth IRA is funded with after-tax dollars.

Traditional IRA Contribution Limits

For 2008 you can contribute up to $5,000. If you will be 50 years old by December 31, 2008 your contribution limit is $6,000. As a married couple the contribution limits are effectively $10,000 and $12,000 as both you and your spouse are eligible for a traditional IRA. Once you turn 70.5 years of age you are unable to contribute further to a traditional IRA. The last contribution limit is that you must have earned income equal to the contribution for that respective year.

Traditional IRA contributions have no income limitations, however, there are income limitations for deducting the value of the contribution.

Traditional IRA Deduction Limits

If you are not covered by an employer retirement plan, you are eligible to deduct your traditional IRA contributions. If you are covered by an employer retirement plan, you may be eligible to deduct your traditional IRA depending on you income. If you’re unmarried, your contribution deductibility begins to phase out if your adjusted gross income (AGI) exceeds $53,000 and completely phases out at $63,000. If you’re married and both you and your spouse is covered by an employer retirement plan, your contribution deductibility begins to phase out if your joint AGI exceeds $85,000 and completely phases out at $105,000.

It gets slightly complicated if only one spouse is covered by an employer retirement plan. For the covered spouse, the contribution deductibility begins to phase out if your joint AGI exceeds $85,000 and completely phases out at $105,000. For the non-covered spouse, the contribution deductibility begins to phase out if your joint AGI exceeds $159,000 and completely phases out at $169,000.

Contributions are still allowed after the fully phased out income limit is reached, you just won’t be able to use it as a tax deduction. If you’ve reached fully phased out income limit, you might want to think about funding a roth IRA instead.

Roth IRA Contribution Limits

The contribution limits for a roth IRA are equivalent to a traditional IRA. One important difference is that you can still make roth IRA contributions once you reach the age of 70.5 if you still have earned income equal to your contribution amount (i.e. income from hobbies).

As opposed to the traditional IRA, the roth IRA has income limitations for contributions. For unmarried individuals, the contribution limit begins to phase out with an AGI of $101,000 and completely phases out at $116,000. For married individuals, the contribution limit begins to phase out with a joing AGI of $159,000 and completely phases out at $169,000.

Unlike a traditional IRA, a funding a roth IRA is not dependent on the availability of an employer sponsored retirement plan.

My IRA Conclusions

As per my goals section, I will be trying to fully fund my Roth IRA as soon as my condo down-payment is complete. I chose to open a roth IRA instead of a traditional IRA because I did not want to have all of my retirement funds taxed as I withdrew money. I am planning on opening a solo 401k and invest all of my self-employed income with pre-tax dollars. Investing with a roth IRA will allow me to have options when I begin to withdraw money from my retirement nest egg. Also, a roth IRA has extra benefits for leaving money for the future generations, which is very appealing.

IRAs are becoming powerful investment vehicles for retirement funds as contribution limits are expected to increase with inflation. Don’t forget to take advantage of one of these retirement funds before the income tax deadline, April 15, 2009.