Retirement Options

There is a direct correlation between accumulating wealth and time. The earlier you invest in some vehicles that could generate a certain return on investment, the more wealth will have at the time you decide to retire. The magical concept of compound interest could help your principle contributions grow into a colossal amounts. For example: you start an investment account at the age of 40 with zero initial investment. You plan to contribute $500 per month and want to retire at 67. You don't know anything about investment, so you elect to have the investment firm does robo-invest for you with a 6% expected rate of return. With 27 year of self-discipline to contribute $500 from your paycheck, your total contribution will be $162,000, but your retirement account grows with the magical compound interest of 6% into $403,273. With this example, it is understandable that you should invest early. With the widespread of information, many people start to invest early. However, have you considered tax application of each investment account or retirement type. We will discuss about 4 investments you could do early or right now to help build your wealth.

General Investment Account

When individual think of open an investment, they don't often think about retirement plans like IRA, Roth IRA, or 401k, but they open a regular investment account.

The pros are:

• No contribution limitation

• No age requirement. Parents can immediately open custodial investment account right after they receive the child's Social Security Number

The Cons are:

• Tax when you realized (sell) the investment

• Tax on Dividends/Interest Income

• Net Loss is capped at $3000 per year. It could only offset against other investment gains

Individual Retirement Account (IRA)

It is easy to open an Individual Retirement Account (IRA) as many banks and financial institutions offer free account on their platforms. It requires no investment knowledge as financial institutions offer their advisor service with minimal fees. The following are characteristics of an Individual Retirement Account (IRA):

• You must have taxable compensation to open an IRA

• You only contribute up to $7000 annually in 2025

• Contribution to a Traditional IRA is tax deductible, which means you get a deduction in your personal tax return for amount you contributed, but it is phased out if your Modified Adjusted Gross Income (AGI) is more than $87,000 single filer or $143,000 married filers

• Contribution to a Roth IRA isn't deductible, which means you don't get deductions for amounts you contributed, however, your capital gain/growth in your Roth IRA is tax-free when you withdraw after age 59 1/2. If your Modified AGI is more than $161,000, you can't contribute to Roth IRA. Married filing jointly modified is more than $240,000.

• Traditional IRA has a Required Minimum Distribution at age 70 1/2. There is no Required Minimum Distribution for Roth IRA if it is an original owner.

• Taxable withdrawal from Traditional IRA, but nontaxable withdrawal from Roth IRA

• 10% penalty applies if early withdrawal before age 59 1/2 with a few exceptions

Considering the different between Traditional IRA and Roth IRA, I always recommend clients to open a Roth IRA. With the tax deduction of Traditional IRA in current year wouldn't be helpful in lower your tax liability. In addition, you have to pay taxes on your early withdrawal or in your retirement years. These characteristics should eliminate Traditional IRA from your retirement portfolios. But with Roth IRA, you pay no taxes on withdrawal in your retirement age. No taxes on early withdrawal, but 10% penalty applies. No requirement minimum distribution is a plus.

Simplified Employee Pension Plan (SEP) IRA

Simplified Employee Pension Plans (SEP) IRA is another retirement that allow employers to set aside money for themselves and their employees. It can be used by any size of business entity: sole proprietor, partnership member, a disregarded LLC, Corporation and S-corporation. The plan is easy to setup and maintain. The SEP IRA features are:

• Easy to setup and maintain

• Low administrative costs

• Flexible annual contribution - good plan if cash flow is an issue

• Allows for a contribution of up to 25 percent of each employee's pay. Contribution cannot exceed the lesser of

  • 25% of the employee's compensation or

  • $69,000 for 2024

• Only Employer contribute to the plan and employer must contribute equally for all eligible employees

• 10% Penalty if under age 59 1/2

• There is an option for Roth SEP IRA if you want tax free withdrawal at retirement age

SEP IRA is a popular for sole proprietors and partners of partnership because SEP IRA allows a greater than $7,000 contribution limit of traditional IRA.

401(k) Plan

A 401(K) Plan allows employees contribute a portion of their wages into individual accounts. There are Traditional 401(k) and Roth 401(k). If an employer has a 401(k) for the company, elective salary deferrals are excluded from employee's taxable income except for Roth 401(k). For example, an employee earns 100,000 annually. If the employee elects to $20,000 deferral, his/her W-2 will be $80,000 at the year end. But if the company has Roth 401(k) and the employee elects to contribute into Roth 401(k), $100,000 will be reported on his/her W-2. 401(k) plan's feature are:

• Plan setup is complex and requires investment fees

  • Participants must be over 21

  • Must at least 1 year of service

  • Vesting requirements

• You can borrow from the plan, and loan secured by benefits

• Contribution or benefits must not discriminate

• Employee's annual contribution $23,000 in 2024, Additional 7,500 if the participant is 50 or over.

• Employer can match contributions with participants' contribution, but the contribution cannot exceed the lesser of:

  • 100% of the participant's compensation or

  • $69,000 for 2024

• Participants' contribution is fully vested; however, the employer can set up a 401(k) plan with limits and restriction such as working certain numbers of years in a matching contribution plan.