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Can You Be Saving More?

Take some simple steps to make the most of your money

Yellow box full of money. Savings vehicles you probably aren't taking advantage of.

Review your savings options regularly. Your circumstances may have changed and there may be better ways for you to save money. — Tetra Images/Alamy

En español | Your savings grow faster when you use every available tax break. Luckily, that doesn't take an accounting degree. All you really need to understand are the key differences among 401(k) plans, traditional IRAs, Roth IRAs, SEP-IRAs and ordinary taxable accounts.

Each of these accounts has different advantages and disadvantages, so it's usually a good idea to own more than one. It's also smart to review your savings options annually because, in many cases, eligibility requirements, contribution limits and tax treatment depend on your age, income and employment situation.

If your new job pays less than the old one, for example, you may now qualify for a tax-deductible IRA. Over 70 1/2 and still working? You're no longer eligible to contribute to a traditional IRA, but you may still be able to save in a Roth IRA. Earning freelance income? You qualify for a SEP-IRA (stands for Simplified Employee Pension) regardless of your age, employment status and other earnings.

Here's what you need to know:

401(k) plans

• Your contributions cut your current tax bill by reducing your taxable income. If you earn $65,000 a year and contribute $8,000 to your 401(k), for example, you'll pay income taxes on only $57,000.

• Many employers match your contribution. Companies that do contribute typically kick in 50 cents for each dollar you save, up to 6 percent of your salary.

• You pay taxes only on your withdrawals.

• When you leave a job, you can keep your account growing untaxed by transferring it into a traditional IRA.

The downside:

• Your withdrawals are subject to ordinary income taxes, plus a 10 percent early withdrawal penalty depending on your age. (The penalty is waived if you leave the job at age 55 or older; otherwise it applies until you're 59 1/2.) The tax on withdrawals means your account isn't as big as it looks. For example, if your combined federal, state and local tax bracket is 28 percent in retirement, you'll keep only 72 percent of each withdrawal.

• You must start taking minimum annual withdrawals after turning age 70 1/2. (The only exception: You're not required to take distributions from your current employer's 401(k) plan unless you own 5 percent or more of the company you work for.)

Eligibility: Full-time employees must be allowed to participate in their employer's 401(k) plan after 12 months of service if they're over age 21.

Contribution limits: The government caps 2014 contributions at $17,500, or $23,000 if you're 50 or older, thanks to the $5,500 catch-up contribution. But your plan may set lower limits.

What to consider: It's a no-brainer to contribute enough to take full advantage of your employer's match. Before deciding how much more to contribute, compare the plan to the available alternatives. If your 401(k) is mediocre due to limited investment choices, lackluster performance or high fees, you may prefer to maximize contributions to your spouse's workplace retirement plan, or to an IRA.


You must have earned income to contribute to a traditional IRA or to a Roth IRA; and even if you have earned income, you can't contribute to a traditional IRA after age 70 1/2.

Traditional tax-deductible IRAs:

• Contributions reduce your taxable income.

• You're taxed only on withdrawals.

• Your investment choices are almost unlimited. You can put virtually any bank, brokerage, mutual fund or insurance product into an IRA.

The downside:

• Your withdrawals are taxed as ordinary income and subject to a 10 percent early withdrawal penalty until you're 59 1/2.

• You must start taking minimum annual withdrawals after age 70 1/2.

What to consider: Are you eligible for a deductible IRA? The answer is yes if you and your spouse didn't participate in a workplace retirement plan during the year. Otherwise, your eligibility for a deduction depends on your income, tax filing status, and whether either of you is covered by a workplace retirement plan. [Check the IRS website for more details].

Traditional nondeductible IRAs:

• Your earnings are untaxed until you withdraw them.

• Your investment selection is almost unlimited.

The downside:

• Your contributions don't reduce your current taxable income.

• Your earnings are taxed as ordinary income when withdrawn and subject to a 10 percent early withdrawal penalty until age 59 1/2.

• Each withdrawal includes some taxable earnings along with tax-free return of contribution.

• You must start taking minimum annual withdrawals after you turn 70 1/2.

What to consider: A nondeductible IRA makes sense only if you're ineligible for a traditional deductible IRA (see eligibility rules above) and your earnings disqualify you for a Roth IRA.

Contribution limits: The maximum amount you can put into a traditional tax-deductible IRA, a traditional nondeductible IRA or a Roth IRA is the same: In 2014, it's $5,500, or $6,500 if you were at least age 50 at year's end. You can also divide this maximum contribution between a traditional IRA (deductible or nondeductible) and a Roth IRA if you wish.

Roth IRAs

• Your earnings grow untaxed.

• You can withdraw your contributions at any time, regardless of your age, without incurring a tax or a penalty.

• All Roth withdrawals are tax-free after you're over 59 1/2 and have owned the account five years.

• Your withdrawals don't count as income in the formula that determines whether your Social Security benefit is taxable.

• You're never required to take distributions, regardless of your age.

The downside:

• Your contributions don't reduce your current tax bill.

• Strict eligibility requirements — you may earn too much to contribute. In 2014, eligibility to make contributions phases out for single taxpayers with a modified adjusted gross income (MAGI) between $114,000 and $129,000, and for married taxpayers filing jointly or qualifying widows/widowers with MAGI between $181,000 and $191,000. [Check the IRS website for more details.]

What to consider: Even a modest Roth IRA can enhance your retirement security. Remember, distributions from 401(k)s and traditional IRAs are taxable. If you're in a 28 percent bracket, you'll get 72 cents to spend on living expenses for every dollar you withdraw. Taking those big distributions in a falling market can leave your nest egg too depleted to recover fully. Supplementing your income with tax-free Roth IRA withdrawals lets you trim your taxable distributions in bad times.

You can create a Roth IRA even if you earn too much to make contributions. Here's how: You can move money from a traditional IRA into a Roth IRA. This is called a Roth conversion. But when you do this, you owe taxes on the amount you convert. For example, if you move $50,000 from a traditional IRA to a Roth IRA, the conversion adds $50,000 to your taxable income for the year. To minimize the annual tax bite, you may want to convert $10,000 a year over a five-year period.


• Contributions reduce your taxable self-employment income.

• You owe taxes only on withdrawals.

• A SEP is as easy to set up as a traditional IRA.

• You can save much more than you could in a regular IRA.

• There's no age limit on contributions.

The downside:

• Withdrawals are taxed as ordinary income and subject to a 10 percent early withdrawal penalty until you're 59 1/2.

• You must start taking minimum annual withdrawals after you turn 70 1/2.

Eligibility: Any employer, including a self-employed person, can establish a SEP-IRA.

What to consider: If you have freelance income, even in retirement, contributing to a SEP-IRA can cut your tax bill. In 2014, you can contribute either 25 percent of your self-employment income or $52,000, whichever is smaller.

Taxable Accounts

• There are no age, income or contribution restrictions.

• There are no minimum required distributions.

• You can usually withdraw your contributions anytime without tax or penalty.

• If you invest in a capital asset (like stocks or real estate), your profit is taxed as a capital gain, at a substantially lower rate than ordinary income.

The downside:

• Your contributions don't reduce your taxable income.

• Your earnings are taxable.

What to consider: Many experts believe ordinary income tax rates will rise in the future. Taxable accounts also help diversify your nest egg.

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