Mutual Funds For Dummies. Eric Tyson

accounts described in this chapter, for every $1,000 you contribute, you save yourself about $350 in taxes in the year that you make the contribution. That means you have $1000 in your retirement savings and $350 in your pocket that didn’t go to federal and state income taxes versus just $650 left for you after taxes if you don’t contribute. You can invest all of this savings until it’s taxed when withdrawn in retirement. Some employers will match a portion of your contributions to company-sponsored plans, such as 401(k) plans — getting you extra dollars for free.

      On average, most people need about 70 to 80 percent of their annual preretirement income throughout retirement to maintain their standard of living. If you haven’t recently thought about what your retirement goals are, looked into what you can expect from Social Security (okay, cease the giggling), or calculated how much you should be saving for retirement, now’s the time to do it. My book Personal Finance For Dummies (Wiley) goes through all the necessary details and explains how to come up with more money to invest.

      When you earn employment income (or receive alimony), you have the option of putting money away in a retirement account that compounds without taxation until you withdraw the money. With many retirement accounts, you can elect to use mutual funds as your retirement account investment option. And if you have retirement money in some other investment option, you may be able to transfer it into a fund company (see Chapter 16).

      

If you have access to more than one type of retirement account, prioritize which accounts to use by what they give you in return. Your first contributions should be to employer-based plans that match your contributions. After that, contribute to any other employer or self-employed plans that allow tax-deductible contributions. If you’ve contributed the maximum possible to tax-deductible plans or don’t have access to such plans, contribute to an IRA. The following sections include the major types of accounts and explain how to determine whether you’re eligible for them.

      401(k) plans

      For-profit companies typically offer 401(k) plans, which typically allow you to save up to $20,500 per year (tax year 2022), $27,000 for those 50 and older. Your contributions to a 401(k) are excluded from your reported income and are free from federal and state income taxes but not from FICA (Social Security) taxes.

      

Absolutely don’t miss out on contributing to your employer’s 401(k) plan if your employer matches a portion of your contributions. Your company, for example, may match half of your first 6 percent of contributions (so you save a lot of taxes and get a bonus from the company). Check with your company’s benefits department for your plan’s details.

      Smaller companies (those with fewer than 100 employees) can consider offering 401(k) plans, too. In the past, administering a 401(k) was prohibitively expensive for smaller companies. If your company is interested in this option, contact a mutual fund organization, such as T. Rowe Price, Vanguard, or Fidelity, or a discount brokerage house, such as Charles Schwab or Sharebuilder.

      403(b) plans

      Many nonprofit organizations offer 403(b) plans to their employees. As with a 401(k), your contributions are federal- and state-tax-deductible. The 403(b) plans often are referred to as tax-sheltered annuities, the name for insurance-company investments that satisfy the requirements for 403(b) plans. No-load (commission-free) mutual funds can be used in 403(b) plans. Check which mutual fund companies your employer offers you to invest through — I hope you have access to the better ones covered in Chapter 9.

      Employees of nonprofit organizations generally are allowed to contribute up to 20 percent or $20,500 of their salaries ($27,000 for those individuals 50 and older) — whichever is less. Employees who have 15 or more years of service may be allowed to contribute more. Ask your employee benefits department or the investment provider for the 403(b) plan (or your tax advisor) about eligibility requirements and details about your personal contribution limits.

      

If you work for a nonprofit or public-sector organization that doesn’t offer this benefit, make a fuss and insist on it. Nonprofit organizations have no excuse not to offer a 403(b) plan to their employees. This type of plan includes virtually no out-of-pocket setup expenses or ongoing accounting fees like a 401(k) (see the preceding section). The only requirement is that the organization must deduct the appropriate contribution from employees’ paychecks and send the money to the investment company that handles the 403(b) plan. (Some state and local governments offer plans that are quite similar to 403(b) plans and are known as Section 457 plans.)

      Small business plans

      

If you’re self-employed or a small-business owner, you can establish your own retirement savings plans. Simplified employee pension individual retirement account (SEP-IRA) plans require little paperwork to set up. They allow you to sock away 20 percent of your self-employment income (business revenue minus expenses) up to a maximum of $61,000 per year. Each year, you decide the amount you want to contribute — you have no minimums. Your contributions to a SEP-IRA are deducted from your taxable income, saving you big-time on federal and state taxes. As with other retirement plans, your money compounds without taxation until withdrawal.

      Individual Retirement Accounts (IRAs)

      Anyone with employment (or alimony) income can contribute to Individual Retirement Accounts (IRAs). You may contribute up to $6,000 each year ($7,000 if you’re age 50 and older) or the amount of your employment or alimony income if it’s less than these amounts in a year. If you’re a nonworking spouse, you may be eligible to contribute into a spousal IRA.

      Your contributions to an IRA may be tax-deductible. For the tax year 2022, check out these eligibilities:

       If you’re single and your adjusted gross income (AGI) is $78,000 or less for the year, you can deduct your IRA contribution.

       If you’re married and file your taxes jointly, you’re entitled to a full IRA deduction if your AGI is $129,000 per year or less.

      If you make more than these amounts, you can still take a full IRA deduction if you aren’t an active participant in any retirement plan. To know for certain whether you’re an active participant, look at the W-2 form that your employer sends you early in the year to file with your tax returns. Little boxes indicate whether you’re an active participant in a pension or deferred-compensation plan. If either box is checked, you’re an active participant.

      If you’re single taxpayer with an AGI above $68,000 but below $78,000, or part of a couple with an AGI above $109,000 but below $129,000, you’re eligible for a partial IRA deduction, even if you’re an active participant. The size of the IRA deduction you may claim depends on where you fall in the income range. For example, a single-income earner at $73,000 is entitled to half of the full IRA deduction (assuming they are under age 50) because their income falls halfway between $68,000 and $78,000. (Note: These thresholds are for tax year 2022. They’ll increase in the tax years ahead.)

If you yourself are not an active participant in a retirement plan but your spouse is an active participant, then you may take a full IRA deduction if your AGI is $204,000 or less. A partial deduction is allowed in this case if your AGI is between $204,000 to $214,000.

      

If you can’t deduct your contribution to a standard IRA account, consider