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Retirement Account Patchwork

If you imagine that the U.S. congress would create a simple, easy-to-understand system for determining when you can make contributions to retirement accounts, and which accounts, and how much, then you would be totally wrong. Nobody knows why the patchwork of ages, accounts, and contribution amounts has to be so complicated, but this is the world we have to live in.

This year, the contribution limit for both traditional and Roth IRAs is $6,000—but you can only make that contribution if your taxable income is greater than that amount. Otherwise, you would just be able to contribute the lesser taxable income amount. People age 50 and older are entitled to contribute an additional $1,000. But (here’s where it starts to get complicated) people over age 70 1/2 currently cannot continue to contribute to a traditional IRA. But people of any age can contribute to a Roth IRA, so long as the household earns enough money.

You probably already know that your Roth IRA contribution will be part of your taxable income, while the traditional IRA contribution is not taxed until it comes out, and then it’s taxed as ordinary income, not capital gains. But when you take the money out of a Roth IRA, the distribution is not taxable. Thus, with each account, the government avoids double taxation. More complexity: people over age 70 1/2 are required to start taking distributions from a traditional IRA account, with the percentage of the total account growing each year, based on the government’s life expectancy tables. Roth IRA money doesn’t have to be distributed until or unless the account is inherited.

When Roth or traditional IRAs are inherited, some of the money must be distributed to each of the heirs under relatively complex rules that are, once again, based on the life expectancy of the new owner. But whatever money is still in the account is able to continue to compound tax-free.

For Simplified Employee Pension (SEP) plans, employers are allowed to contribute 25% of an employee’s compensation, or $56,000, whichever is lower.

If your company has a Savings Incentive Match for Employees (SIMPLE) retirement plan, then the limit this year is $13,000 for employees under age 50, and $15,000 for employees over 50. But if the employee is participating in another employer plan (say, a 401(k) plan) during the year, the cumulative contribution amount for both plans cannot exceed $19,000. More complexity: there is no upper age limit to contributing to a SEP account, so long as the employee is still working and earning an income. But (more complications) unlike the other accounts here, people under age 21 cannot contribute to a SEP account.

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