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3 Surprising Things to Know About Retirement Plans

Matthew Frankel, CFP, The Motley Fool

The details of retirement savings accounts like 401(k) plans and IRAs aren’t well understood by too many Americans, and here are three things you might be happy to learn.

A woman with a shocked expression on her face.

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Many Americans have a basic knowledge of retirement accounts, but there are a lot of things about retirement savings that aren’t well understood by most people. For example, did you know that in some cases, you might be able to use your retirement savings before you retire, without paying a penalty to the IRS?

Here are the details of this, and two other surprising facts about retirement plans that you should know in order to maximize your savings and set yourself up for financial independence.

Your money isn’t necessarily tied up until you retire

As a Certified Financial Planner®, one of the most common things I hear when I suggest that people increase their retirement contributions is, “I don’t want that much money tied up until I’m almost 60.”

It’s true that most tax-deferred retirement accounts cannot be accessed before you turn 59 ½ years old, but there are some exceptions. Just to name a few of the most common:

  • If you have an IRA, you can use up to $10,000 of your account penalty free towards a first-time home purchase, either for you or someone else.

  • IRA funds can also be used penalty free to pay for qualified higher education expenses in any amount.

  • If you have a 401(k), you can withdraw money from the account when you turn 55, as long as you’re no longer working for the sponsoring employer. This is known as the “separation from service” exemption.

In addition to these exceptions, if you contribute to a Roth IRA, you can withdraw your original contributions at any time, and for any reason, without penalty. You can’t tap your investment gains until you’re 59 ½, or until one of the other IRA exemptions apply, but it’s important to realize that the money you put into a Roth IRA through your brokerage isn’t really tied up at all.

You may be able to take your time contributing

Generally speaking, 401(k) contributions are made through payroll deduction, and therefore must be made during the calendar year. However, it’s important to realize that this is your employer’s rule, not the IRS’s.

In fact, the IRS allows contributions to most retirement accounts until the tax deadline for a given calendar year. For example, you are allowed to contribute as much as $5,500 to an IRA for the 2018 tax year ($6,500 if you’re 50 or older). However, you have until April 15, 2019 to get your contributions in. The point is that even though it’s close to the end of 2018 as I’m writing this, you still have several months to make your 2018 IRA contributions.

Some types of retirement brokerage accounts even let you make contributions until the extended tax deadline. If you’re self-employed, an individual 401(k) account will allow you to do this. Contribution limits to 401(k) accounts are far higher than IRA limits, so if you open one mid-year, you might be thankful that you have until the following October to make your annual contributions.

You could have a 401(k) and an IRA

It’s a common misconception that if you have a 401(k) or other retirement plan through your employer that you aren’t allowed to open and contribute to an IRA as well. This is completely false.

The only caveat is that your ability to take advantage of the traditional IRA tax deduction is income restricted if you (or your spouse) have an employer-sponsored retirement plan. Here are the income limitations for the 2018 and 2019 tax years if you participate in an employer’s retirement plan:

Tax Filing Status

2018 Traditional IRA Full Deduction AGI Limit

2019 Traditional IRA Full Deduction AGI Limit

Single or Head of Household

$63,000

$64,000

Married Filing Jointly

$101,000

$103,000

Married Filing Separately

$0

$10,000

Data source: IRS.

If you don’t have an employer-sponsored retirement plan, but your spouse does, the traditional IRA deduction income limits are a bit more generous:

Tax Filing Status

2018 Traditional IRA Full Deduction AGI Limit

2019 Traditional IRA Full Deduction AGI Limit

Married Filing Jointly

$189,000

$193,000

Married Filing Separately

$0

$10,000

Data source: IRS.

Finally, it’s worth pointing out that the ability to contribute to a Roth IRA is limited by income, regardless of whether you have an employer’s retirement plan:

Tax Filing Status

2018 Roth IRA Full Contribution AGI Limit

2019 Roth IRA Full Contribution AGI Limit

Single or Head of Household

$120,000

$122,000

Married Filing Jointly

$189,000

$193,000

Married Filing Separately

$0

$10,000

Data source: IRS.

The bottom line is that having an employer’s retirement plan all by itself doesn’t prevent you from also investing for your retirement through an IRA. In fact, an IRA can be a great supplement to your employer’s plan.

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