Retirement Investments in the USA - Essay Example

Retirement Investments in the USA Introduction Planning for life after retirement should begin before retirement. What a person needs after retirement may influence the road map or action plan prepared by the person before retirement. If not prepared the action plan wisely, retirement life may cause problems. The investment decisions taken before the retirement may influence the person till his death and hence it is necessary for retiring people to take utmost care while planning their investments before retirement. Even though many retirements plans are available in United States, none of them seems to be 100% satisfied to the people. Some of them may look good on papers but in practice it may not bring dividends to the retired people. Some other investment plans are exempted from tax at the time of investments, but on maturity people were forced to pay heavy amounts as taxes. This paper analyses benefits and drawbacks of various retirement options available in United States at present like the IRA, Roth IRA, SEP IRA, 401k and Roth 401k etc. IRA vs Roth IRA IRA refers to Individual Retirement Accounts whereas Roth IRA (named after its legislative sponsor William Roth) refers to an Individual Retirement Arrangement (IRA) allowed under the tax law of the United States. Kennon (2010) has mentioned some of the major advantages and disadvantages of IRA’s and Roth IRA’s. In his opinion IRA’s are attractive because; IRA taxes are paid only on earnings, it is available to everyone without any income restrictions, funds can be used to purchase a variety of investments like stocks, bonds, certificates of deposits etc (Kennon). Some of the retirement investment options available in America at present are constrained to ordinary people because of the income restrictions. For example Roth IRA schemes are available only to a particular community who earns more. The investor in IRA’s need not worry much about the taxes as the tax is calculated based on the earnings rather than the principal amount. For example, it is possible that an investor in an IRA scheme may gain or lose heavy amounts because of the fluctuations in stock market. Only the persons who gain something from their investments need to pay taxes whereas the losers need not pay anything as taxes in case of IRA’s. The major drawbacks of IRA’s are related to the withdrawal rules according to Kennon (2010). Investments in IRA’s cannot be continued by an investor when he crosses the age of 70.5 years. Moreover, an investor needs to pay 10% penalty if the funds were withdrawn before the age of 59.5 years (Kennon). These rules are definitely an area of concern for an investor. For example, suppose an investor suffered some serious diseases before he reaches his 59.5 years of age, he cannot withdraw the money without penalty. Same way it is impossible for an investor to keep his investment growing considering the growth potentials of the share market, even after maturity or the investor reaches his 70.5 years. Roth IRA’s are free of many of the disadvantages of the IRA’s. In the case of Roth IRA’s; contributions are not tax deductible, no mandatory distribution age, all earnings and principal are 100% tax free if rules and regulations are followed, funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.), principal contributions can be withdrawn any time without any penalty etc (Kennon). The major disadvantage about the age restrictions for maintaining and withdrawing money in the case of IRA’s are not there for the Roth IRA’s. Investors can withdraw their money any time they like without any penalty and moreover they can continue their investments as long as they like without any age bars, in the case of Roth IRA’s. It is possible for an investor to join Roth IRA even if he is involved in a retirement plan such as 401 (k). Moreover, in case of death of an investor in Roth IRA, the sole beneficiary would be able to combine his/her own IRA with that of the dead person The major disadvantage of Roth IRA is the restriction with respect to the income of the investor. Roth IRA’s are intended for the wealthy people and it is impossible for the ordinary people to join in such schemes. In other words, Roth IRA schemes are dividing the society as the rich and poor. It is possible that the Congress may change the rules time to time which may affect the investments in Roth IRA’s positively or negatively. 401k and Roth 401k The Roth 401(k) is a retirement savings plan authorized by the American Congress. It offers the benefit of different tax structures for the same investor’s investments. It combines some of the most advantageous aspects of both 401(k) and Roth IRA. Roth 401(k) offers a tax free income after retirement, but it has many disadvantages also. Pritchard (2010) has pointed out that the investor in Roth 401(k) scheme may not get current year tax deduction and the investments are vulnerable to the future tax laws. Moreover, in his opinion, long term planning is impossible in the case of Roth 401(k) schemes (Pritchard). Roth 401 (k) creates tax burdens after the investments were made whereas the normal 401(k) is free of such burdens as normal 401(k) collects taxes at the time of investment. Roth 401 (k) is more suitable to the young investors because of the absence of any age barrier for investments whereas normal 401 (k) is suitable only to the retiring people because of the age barrier. Education Savings Accounts Gobel (2010) has mentioned that Coverdell Education Savings Account allows individuals to deposit up to $2,000 per year in an educational investment account without being taxed on earnings from interest, dividends, appreciation etc (Gobel). Educational expenses are growing at alarming rates in most of the countries and United States is also not an exception. In fact many of the retired persons struggled to find enough financial resources for giving proper education to their children. On the other hand, a person who started to invest in education savings accounts before retirement need not worry about such difficulties. In fact Education Savings Accounts offer double advantages; an investor would be able to save immense amount of tax money and at the same time able to keep some money for the future educational needs of his children. SEP IRA and how it applies to self employed individuals and small businesses Simplified Employee Pension Individual Retirement Account, commonly known as SEP IRA is a form of Individual Retirement Account, popular in the United States. SEP IRAs are normally adopted in small organizations in order to provide retirement benefits both to the employees and the employers. SEP IRA’s are similar to normal IRA’s except the fact that it is intended for the companies of business organizations. It is applicable to the self employed people even if he does have some employees. The employer should provide at least 25% of the employee's annual wages to the employee's SEP-IRA account. In other words, if an employee draws an annual salary of$ 100000, the employer should pay $25000 to the employee's SEP-IRA account. “Employees do not pay taxes on SEP contributions, but these contributions are taxed when the employee receives a distribution from the SEP IRA” (SEP IRAs: Introduction). Even though the employees need not pay any taxes at the time of their employment, they should pay taxes after their retirement. The employer and the employee should have a traditional IRA account in order to deposit the SEP IRA investments. Only an employer can establish an SEP IRA even if it is intended for the employees. The employees should have crossed the minimum age of 21 at the time of joining SEP IRA. Like most of the other retirement investment plans, SEP IRA’s are also not free of drawbacks. Leonard (2010) has mentioned some of the major disadvantages of SEP IRA. In her opinion, the employees are unable to contribute to their own retirement account or to take loans out from their investments in SEP IRA. Moreover, the employer has the disadvantage of keeping the money in the account for employees regardless of how long an employee has been with the company or irrespective of the employee is part time or full time (Leonard). In short, SEP IRAs are best suited to a family run business compared to other small businesses. Conclusions There are lot of retirement investment vehicles available for the investors or the retiring people in United States, but none of them seems to be satisfying the people completely. Some of the investments were good on paper, but the investor will realize the problems only after the investment has been made. The attractive tax structure is the major advantage of the IRA’s. IRA’s are open to all the people whereas Roth IRA’s are open only to the rich people. Withdrawal rules with respect to the age barrier are the most unattractive rule with respect to the investments in IRA’s compared to Roth IRA. The restriction with respect to the income of the investor made Roth IRA highly controversial. Roth 401 (k) creates tax burdens at the time of withdrawal whereas the normal 401(k) collects taxes at the time of investment. While educational savings accounts help an investor to save taxes and saving money for the future educational needs of the children, SEP IRA’s are more suited to the family owned small businesses. Works Cited 1. Gobel, Reyna. 2010. “Education Savings Account: Introduction”. 28 June 2010. 2. Kennon, Joshua. 2010. “Traditional IRA vs. Roth IRA - Which is Better”. 28 June 2010. 3. Pritchard Justin. 2010. “Roth 401k Pitfalls - Disadvantages of Roth 401k Plans Why Roth 401k Might Not be For You”. 28 June 2010. 4. “SEP IRAs: Introduction”. 28 June 2010. Read More