Your Retirement Questions Answered

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Jean Chatzky will be covering a variety of different topics in this space every month. Come back next Tuesday for the fourth article in this month’s Retirement series.

This week, we have answers to some of the retirement questions our small business-owners sent in.  If you have a question for me, please post it in the comments section of this article or on my Facebook page and I’ll do my best to answer it!

A: Caren, you are allowed to do both as long as you’re not an owner of the company that is offering the 401(k).  In other words, if you are just an employee of this company then you can double up and, Ed Slott, CPA and author of Stay Rich for Life, says “you’re probably better off if you do.”  You’re right that for most people, a 401(k) with available matching dollars is the best first move.  But saving as much as you can is the best second move.  If you can max out both, you can put a lot of money away.  How much?  With a SEP, up to 20 percent of your net self-employment income up to $49,000.  (You’d have to make a few hundred thousand to be able to hit that limit, Slott points out.)  Then you can put up to another $16,500 into the 401(k).  Even if you don’t feel as if you can hit those numbers now, it’s nice to know you have the option in the future.

If you’re choosing between the two because you don’t have the money to do both, you’ve made the right choice in going with the SEP. You have more control over the money in the SEP than you do in the 401(k).  Why?  It’s your own plan as opposed to your employer’s plan.  There are no restrictions on your investments.  You have more flexibility.  So I’m with Slott who says: “Max out whatever you can in there first, and then move to the 401(k).”

A: Holly, there are many factors that go into this decision, but you can sort them out by asking yourself two questions, says Slott: When do you need the money? And what do you think future tax rates will be?  Let’s take them one at a time.  If you believe you might need the money before retirement (or don’t believe you will want to withdraw it – ever) the Roth is the way to go.  “The big advantage is that you have access to your contributed funds at any time, for any reason and penalty free,” says Slott.  With a traditional IRA, if you pull money out before retirement, you’ll pay a 10 percent penalty and taxes.  You also don’t have to make Roth withdrawals even in retirement but can pass the entire account along to your kids.  With a traditional IRA, you must begin making withdrawals by age 70 ½.  As for the second question on future tax rates, you get a tax deduction when you make a contribution to a traditional IRA that you don’t get with a Roth.  You want to pay taxes at the lowest rate possible.  So if you believe your tax rate will be higher in the future (or that all tax rates will be higher in the future) a Roth makes more sense.  If you believe your rate will go down, then traditional has its benefits.   And you can, by the way, have both although you have to adhere to the contribution limit of $5,000 a year ($6,000 if you’re 50 or over). 

A:  Alicia, the benefit to a SEP is that you can put substantially more money away in that account than you can in a Roth.  The rules allow you to contribute up to 20 percent of your self-employment income, up to $49,000 for 2010.  So here’s how I’d make the choice.  First, consider whether you’re making the decision for yourself alone or for yourself and employees.  If you have employees and are contributing to a SEP for yourself, you have to cover them as well by contributing the same percentage you put away for you.  So, if you put away the full 20 percent for yourself, you have to do the same for the people who work for you.  Second, if you’re making the decision just for you, then use this barometer: If you can afford to contribute more than $5,000 (or $6000 for people 50 or over) then I’d choose the SEP over the Roth.  But if you can only afford to contribute $5,000 ($6,000 for people 50 or over) or less, then I’d go with the Roth.  Why?  You have the same flexibility to choose investments in either account.  Both are baskets and you can fund them with whatever you choose.  But the Roth, as I described in the last question, has other advantages.  You can get at contributions without penalty and can pass the account to your heirs. 

Jean Chatzky, award-winning journalist and best-selling author, is the financial editor for NBC's "Today," a contributing editor for More magazine, and a columnist for The New York Daily News. She is the author of six books, including her newest, Money 911: Your Most Pressing Money Questions Answered, Your Money Emergencies Solved. Check out Jean's blog at JeanChatzky.com. You can also follow her on Twitter and Facebook.

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