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CRPC: Personal Retirement Savings Vehicles (IRAs, Annuities, and Small-Business Plans)

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Personal Retirement Savings Vehicles (IRAs, Annuities, and Small-Business Plans)

IRAs

Traditional IRA contributions may be deductible depending on workplace-plan coverage and modified AGI. Growth is tax-deferred and distributions are ordinary income. Withdrawals before 59 and a half generally incur a 10% penalty plus tax, with exceptions that include disability, first-time home purchase up to $10,000, qualified higher education, and substantially equal periodic payments under 72(t). Roth IRA contributions are not deductible; qualified distributions are tax-free after five years and age 59 and a half, death, disability, or first home. Roth IRAs have no lifetime RMDs, and contribution income limits drive backdoor Roth strategies.

Annuities

Deferred annuities accumulate tax-deferred, and annuitization converts principal into income. Fixed, variable, and indexed contracts differ in who bears investment risk. Costs include mortality and expense charges, surrender charges, and rider fees. Nonqualified annuities use an exclusion ratio to separate return of basis from taxable gain, and gains withdrawn before 59 and a half generally face a 10% penalty.

Small-business plans

SEP-IRA: employer-only contributions up to 25% of compensation (20% of net self-employment income after the deduction), subject to a dollar cap. SIMPLE IRA: employee deferrals plus a 3% match or 2% nonelective, with a 25% early-withdrawal penalty in the first two years. Solo 401(k): deferrals plus employer contribution, which often allows larger contributions at moderate income than a SEP.

Traps

  • Placing an annuity inside an IRA, which adds cost with little added tax benefit.
  • Computing a SEP contribution on gross self-employment income instead of net earnings after the deduction.
  • Ignoring the Roth IRA phase-out, then failing to use a backdoor Roth.
  • Missing the SIMPLE plan's steeper first-two-year penalty.

Rule of thumb

Contribute to the Roth while in a low bracket and to the traditional account while in a high bracket, then manage brackets in retirement.