The IRS sets the rules for both IRAs and qualified retirement plans. IRAs and qualified plans are similar in several ways but have one noteworthy difference: An IRA is a retirement account for one person, while qualified retirement plans are owned and administered by employers. With both, the onus is on you, not your employer, to plan for your retirement savings needs. A traditional IRA also allows your contributions to be tax-deferred until you begin withdrawals.
Similar to the rules for qualified employer plans, your contributions to traditional IRA accounts are made with pre-tax money. You defer tax consequences until you withdraw funds after retirement or age 70 1/2, whichever comes first. If you need to withdraw funds before the year in which you turn 59 1/2, you will not only pay income taxes, but you may be subject to a 10 percent penalty from the IRS. Many employer-sponsored qualified plans also include pre-tax company contributions, which are not a part of a traditional IRA.
You fund a Roth IRA with after-tax dollars. However, when you withdraw funds, you face no tax consequences on your own contributions -- the portion of your account that equals your contributions is tax-free. Also, if you don't want to withdraw funds by the age of 70 1/2, the IRS will not force you to take required withdrawals of money. Depending on the rules of an employer qualified plan, you may or may not enjoy this choice.
SEP and Simple IRAs
These IRAs are more similar to qualified plans because employers can set up these retirement accounts and contribute to them. As more hybrid forms of retirement programs, they are a combination of IRAs and qualified plans, subject to their own IRS regulations. Smaller employers often choose these options because they offer lower administrative expenses, as well as incurring fewer monitoring and management responsibilities. Employers have no vesting privileges, as each employee owns 100 percent of his account balance immediately.
The most popular type of qualified plan is the 401(k), While an employer owns the plan, employees set up their own accounts with assistance from plan administrators and providers. Typically, these qualified plans are offered by mutual funds or insurance companies to employers. Qualified plans are administered by the employer, not the employee. Employers have the option of establishing vesting rules for their contributions to the plan, which means employees may not own all employer contributions right away but must work for a specified period before these contributions are vested. However, like IRAs, except for the Roth variety, employer and employee contributions are tax-deferred.
Another difference in IRAs and 401(k) qualified plans are contribution maximums. Both traditional and Roth IRAs have annual limits of $5,500 for 2013, with a $6,500 maximum if you are 50 years of age or older. Defined contribution qualified plans, such as 401(k) programs, have an employee maximum contribution of $17,500 in 2013, with a catch-up contribution limit of an additional $5,500 for those 50 and over.
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