IRA & 401k Rules for Retirement

As we are constantly reminded these days, investing for the future is one of the most important step we can take, and the earlier the better. Two of the most popular plans are the standard 401k plan and the Individual Retirement Account (IRA) plans. However, its more important than ever to understand the basics, as the IRA and 401k rules are constantly changing.

For most employees, the easiest option would be to go for the 401k plan, which is offered by a large percentage of companies throughout the United States. All contributions to this plan will be invested with pre tax dollars. Being a deductible investment, you will be able to take advantage of the obvious immediate tax advantages. However, it is important to understand that taxation will apply upon retirement, so the full value of the plan will not be realized. This is fine if you will increase your earning potential consistently through your career, but not so good if you are peaking, or close to peaking.

As with all plans, contributions are limited throughout each tax year. For 2009 the 401k rules are set at a $16,500 limit, however, if you're over 50 years old you can also contribute an additional $5,500, in a 'catch-up' provision. This takes the total potential investment up to $22,000 per year.

Possibly the greatest benefit within the 401k rules, is the 'company match programs: where the employer can match a certain percentage of their employees pay in contributions each year. These limits are set internally, and can vary in their generosity as a result. Many companies offer a 100 percent match. If this is the case with you, you'll want to take full advantage. After all, where are you going to find a 100 percent return on your money? Definitely a good deal if your fortunate enough to get this 401k benefit.

Next to consider are the IRA plans. IRA plans allow for various options, most popular in these are the Traditional IRA, and the Roth IRA.

Similar in concept to the 401k plan, the traditional IRA is tax deductible, which gives an immediate tax break, but potentially higher taxes upon retirement, according to personal circumstances.

This is not the case with a Roth IRA, which is non deductible for contributions. However, the bug benefit with the Roth IRA is the income is free from tax when withdrawn upon retirement. This is popular for this reason of course - with many wanting to have the assurance of knowing their investment cannot be forfeited in anyway upon retirement.

Both IRA plans do not allow for a company match initiative, as they are not linked with any institutions. These are personal plans, operated and maintained wholly by the individual. In both IRAs, contributions are limited according to age: $6000 for those over 50 and $5000 for the those under 50. As with all retirement plans, these limits will be adjusted according to inflation in October 2009 by the IRS.

What is true of both IRA rules and 401k rules, regards early withdrawal. No matter the reason, if an early closure is required, there will be severe penalties imposed, significantly reducing the amount entitled for recovery. The standard retirement age for both these retirement plans is 59 1/2, so you'll need to wait until that age, unless you meet certain limited criteria.

It's important to understand that the IRA and 401k Rules explained here are for guidance purposes only. Before deciding to enter into any financial risk, you should seek counsel from qualified professionals.