iras 401ks and other retirement plans, taking your money out 7th (2006)

IRAs, 401(k)s,
& Other Retirement Plans
Taking Your Money Out
by Twila Slesnick, Ph.D., Enrolled Agent
& Attorney John C. Suttle, CPA

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IRAs, 401(k)s,
& Other Retirement Plans
Taking Your Money Out
by Twila Slesnick, Ph.D., Enrolled Agent
& Attorney John C. Suttle, CPA

7th edition
Seventh Edition JANUARY 2006
Editor AMY DELPO
Cover Design TERRI HEARSH
Book Design TERRI HEARSH
Production
MARGARET LIVINGSTON
Proofreading
ROBERT WELLS
Index ELLEN SHERRON
Printing
DELTA PRINTING SOLUTIONS, INC.
Slesnick, Twila.
IRAs, 401(k)s & other retirement plans : taking your money out / by Twila Slesnick &
John C. Suttle ; edited by Amy DelPo 7th ed.
p. cm.
ISBN 1-4133-0402-8 (alk. paper)

1. Individual retirement accounts Law and legislation United States Popular works. 2.
401(k) plans Law and legislation Popular works. 3. Deferred compensation Law and
legislation United States Popular works. I. Title: IRA’s, 401(k)s, and other retirement
plans. II. Suttle, John C. III. DelPo, Amy, 1967- IV. Title.
KF3510.Z9S55 2006
343.7305'233 dc22
2005054707

Copyright © 1998, 2000, 2001, 2002, 2004, and 2006 by Twila Slesnick and John C. Suttle.
ALL RIGHTS RESERVED. Printed in the U.S.A.
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Acknowledgments
Thanks to Nolo editor Robin Leonard for her intelligent and skillful editing on the first
edition—and for adding a dose of levity to the entire process. For all other editions,
thanks to Nolo editor Amy DelPo for her keen eye and clear thinking. We are also
grateful to attorney Charles Purnell for reading the entire manuscript more carefully
than we had any right to expect. His suggestions were valuable and much appreciated.
Thanks also to Robert and Joan Leonard, and Gail Friedlander, for reading parts of the
manuscript. And finally, a special thanks to Durf, partner extraordinare, and to Jack
and Betty Suttle who have made it possible to balance single parenthood and a profes
-
sion.

Table of Contents
I
How to Use This Book
1
Types of Retirement Plans
A. Qualified Plans 1/4
B. Individual Retirement Accounts
1/9
C. Almost-Qualified Plans
1/13
D. Nonqualified Plans
1/14
2
An Overview of Tax Rules
A. Taxation Fundamentals 2/3
B. General Income Tax Rules for Retirement Plans
2/8
C. Income Tax on Qualified Plans and Qualified Annuities
2/12
D. Special Income Tax Rules for Tax-Deferred Annuities
2/30
E. Special Income Tax Rules for IRAs
2/31
F. How Penalties Can Guide Planning
2/34
3
Early Distributions: Taking Your Money Out
Before the law Allows
A. Exceptions to the Early Distribution Tax 3/2
B. Calculating the Tax

3/8
C. Reporting the Tax
3/9
D. Special Rules for IRAs
3/15
4
Substantially Equal Periodic Payments
A. Computing Periodic Payments 4/4
B. Implementing and Reporting Your Decision
4/12
C. Modifying the Payments 4/14
5
Required Distributions: Taking Money Out
When You Have To
A. Required Distributions During Your Lifetime 5/3
B. Death Before Required Beginning Date
5/4
C. Death After Required Beginning Date
5/5
D. Special Rules for Tax-Deferred Annuities
5/5
E. Special Rules for Roth IRAs
5/6
F. Penalty 5/7
G. Waiver 5/13
6
Required Distributions During Your Lifetime
A. Required Beginning Date 6/3
B. Computing the Required Amount
6/5

C. Designating a Beneficiary
6/10
D. Special Rules for Annuities
6/13
E. Divorce or Separation
6/16
7
Distributions to Your Beneficiary If
You Die Before Age 70
1
/
2
A. Determining the Designated Beneficiary 7/3
B. Distribution Methods
7/5
C. Spouse Beneficiary
7/8
D. Nonspouse Beneficiary
7/14
E. No Designated Beneficiary
7/16
F. Multiple Beneficiaries, Separate Accounts
7/17
G. Multiple Beneficiaries, One Account
7/17
H. Trust Beneficiary
7/23
I. Estate as Beneficiary
7/26
J. Annuities 7/27

K. Divorce or Separation
7/28
L. Reporting Distributions From IRAs
7/29
8
Distributions to Your Beneficiary If
You Die After Age 70
1
/
2
A. Administrative Details 8/3
B. Spouse Beneficiary
8/5
C. Nonspouse Beneficiary
8/10
D. No Designated Beneficiary
8/12
E. Multiple Beneficiaries, Separate Accounts
8/13
F. Multiple Beneficiaries, One Account
8/13
G. Trust Beneficiary
8/17
H. Estate as Beneficiary
8/19
I. Annuities 8/19
J. Divorce or Separation
8/20
9
Roth IRAs

A. Taxation of Distributions 9/4
B. Early Distribution Tax
9/13
C. Ordering of Distributions
9/16
D. Required Distributions
9/17
Appendixes
A
IRS Forms, Notices, and Schedules
Form 4972, Tax on Lump-Sum Distributions A/2
Tax Rate Schedule for 1986
A/6
Form 5329, Additional Taxes on Qualified Plans (Including IRAs)

and Other Tax-Favored Accounts
A/7
Form 5330, Return of Excise Taxes Related to Employee Benefit Plans
A/15
Form 5498, IRA Contribution Information
A/29
Form 8606, Nondeductible IRAs A/30
Revenue Ruling 2002-62
A/40
B
Life Expectancy Tables
Table I: Single Life Expectancy B/2
Table II: Joint Life and Last Survivor Expectancy
B/3
Table III: Uniform Lifetime Table

B/21
Table IV: Survivor Benefit Limits
B/22
Index
Introduction
How to Use This Book
T
his is not a mystery novel. It is a
book about how to take money
out of your retirement plan. We are not
promising that you will stay up all night
breathlessly turning each page to see what
happens next. Nonetheless, you will find
this book useful—perhaps even surprising.
Let’s start with the basics. There are
many kinds of retirement plans and many
possible sources for owning one. You
might have a retirement plan at work, an
IRA that you set up yourself, or a plan or
IRA you’ve inherited. Or you might have
all three. You might still be contributing to
a plan, or you may be retired. No matter
what your situation, you will find informa-
tion in this book to help you through the
minefield of rules.
There are many reasons to take money
out of a retirement plan. You might want to
borrow the money for an emergency and
pay it back—or not pay it back. Maybe you
quit your job and you want to take your

share of the company’s plan. Perhaps you’re
required by law to withdraw some of your
retirement funds because you’ve reached a
certain age.
Whatever your situation, you probably
have a lot of questions about your plan—
and how to take money out of it. This
book can answer:
• How do I know what kind of retire
-
ment plan I have? (See Chapter 1.)
• Do I have to wait until I retire to get
money out of my plan or my IRA?
(See Chapter 3.)
• Can I borrow money from my 401(k)
plan to buy a house? (See Chapters 3,
4, and 5.)
• What should I do with my retirement
plan when I leave my company or
retire? (See Chapter 2.)
• When do I have to start taking money
out of my IRA? (See Chapter 5.)
• How do I calculate how much I have
to take? (See Chapter 6.)
• Can I take more than the required
amount? (See Chapter 6.)
I/2 IRAS, 401(K)S & OTHER RETIREMENT PLANS
• What happens to my retirement plan
when I die? (See Chapters 7 and 8.)
• Can my spouse roll over my IRA

when I die? (See Chapters 7 and 8.)
• What about my children? Can they
put my IRA in their names after I die?
Do they have to take all the money
out of the account right away? (See
Chapters 7 and 8.)
• If I inherit a retirement plan, can I
add my own money to it? Can I save
it for my own children, if I don’t
need the money? (See Chapters 7 and
8.)
• Am I allowed to set up a Roth IRA?
Should I? (See Chapter 9.)
• Can I convert my regular IRA to a
Roth IRA? Should I? (See Chapter 9.)
To help you answer these and other
questions, we include many examples.
They guide you through the decision
making process and take you through
calculations. You will also find sample
tax forms that the IRS requires, along with
instructions for how to complete them.
This book contains tables to help you
calculate distributions. It also contains
sample letters and worksheets you can use
to communicate with the IRS or with the
custodian of your IRA or retirement plan.
We’ve even included some important IRS
notices so you can read firsthand how IRS
personnel are thinking about certain critical

issues.
The tax rules for pensions, IRAs, 401(k)s,
and other types of retirement plans are
notoriously complex, which can be all the
more frustrating because they are impor-
tant to so many people. The good news
is that help is here: This book makes the
rules clear and accessible.
Icons Used Throughout
At the beginning of each chapter,
we let you know who should read
the chapter and who can skip it or read
only parts of it.
Sprinkled throughout the book are
planning tips based on strategies
that other people have used successfully.
We include several cautions to
alert you to potential pitfalls.
■
Chapter 1
Types of Retirement Plans
A. Qualified Plans 1/4
1. Profit Sharing Plans
1/5
2. Stock Bonus Plans
1/7
3. Money Purchase Pension Plans
1/7
4. Employee Stock Ownership Plans (ESOPs)
1/7

5. Defined Benefit Plans
1/8
6. Target Benefit Plans
1/8
7. Plans for Self-Employed People
1/9
B. Individual Retirement Accounts
1/9
1. Traditional Contributory IRAs
1/10
2. Rollover IRAs
1/11
3. Simplified Employee Pensions
1/11
4. SIMPLE IRAs
1/12
5. Roth IRAs
1/13
C. Almost-Qualified Plans
1/13
1. Qualified Annuity Plans
1/13
2. Tax-Deferred Annuities
1/14
D. Nonqualified Plans
1/14
1/2 IRAS, 401(K)S & OTHER RETIREMENT PLANS
Who Should Read Chapter 1
Read this chapter if you aren’t
certain which types of retirement

plans you have—either through your
employer or as a self-employed person.
Also read this chapter if you have an IRA
but aren’t sure which type.
H

ow many people have warned
you that you’ll never see a penny
of the hard-earned money you’ve poured
into the Social Security system and that
you’d better have your own retirement
nest egg tucked away somewhere? Per
-
haps those doomsayers are overstating the
case, but even if you eventually do collect
Social Security, it is likely to provide only
a fraction of the income you will need
during retirement.
Congress responded to this problem
several decades ago by creating a variety of
tax-favored plans to help working people
save for retirement. One such plan is set
up by you, the individual taxpayer, and is
appropriately called an individual retire-
ment account or IRA. Another, which can
be established by your employer or by you
if you are self-employed, is referred to by
the nondescript phrase, a qualified plan.
A qualified plan is one that qualifies to
receive certain tax benefits as described in

Section 401 of the U.S. Tax Code.
There are other types of retirement plans,
too, which enjoy some of the same tax
benefits as qualified plans but are not tech-
nically qualified, because they are defined
in a different section of the Tax Code.
Many of these other plans closely follow
the qualified plan rules, however. The most
common of these almost-qualified plans are
tax-deferred annuities (TDAs) and quali-
fied annuity plans. (Don’t be thrown by
the name. Even though it may be called a
qualified annuity plan, it is not defined in
Section 401 and therefore is not a qualified
plan in the purest sense.) Both of these
plans are defined in Section 403 of the Tax
Code. Because many of the rules in Sec-
tion 403 are similar to those in Section 401,
TDAs and qualified annuity plans are often
mentioned in the same breath with quali-
fied plans.
All qualified plans, TDAs, and qualified
annuity plans have been sweetened with
breaks for taxpayers to encourage them to
save for retirement. And working people
have saved, often stretching as far as they
can to put money into their retirement
plans. But saving is only half the equation.
The government also wants you to take
money out of the plan and spend it chiefly

on your retirement. For that reason, the
government has enacted a series of rules
on how and when you can—or, some-
times, must—take money out of your re-
tirement plan. (When you take money out,
it’s called a distribution.)
What does this mean for you? If you or
your employer has ever put money into a
retirement plan and received tax benefits
as a result, then you cannot simply take
TYPES OF RETIREMENT PLANS 1/3
Helpful Terms
Adjusted gross income (AGI). Total taxable
income reduced by certain expenses
such as qualified plan contributions, IRA
contributions, and alimony payments.
Beneficiary. The person or entity entitled to
receive the benefits from an insurance
policy or from trust property, such as a
retirement plan or IRA.
Deductible contribution. A contribution to
a retirement plan that an employer may
claim as a business expense to offset
income on the employer’s tax return. You
may know it as simply the employer’s
contribution. In the case of an IRA, a
deductible contribution is one that an
individual taxpayer may use to offset
income on the individual’s tax return.
Distribution. A payout of property (such

as shares of stock) or cash from a retire
-
ment plan or IRA to the participant or a
beneficiary.
Earned income. Income received for
providing goods or services. Earned
income might be wages or salary or net
profit from a business.
Eligible employee. An employee qualifies
to participate in the employer’s plan
because he or she has met the eligibility
requirements (such as having worked for
the employer for a specified number of
years).
Nondeductible contribution. A contribu-
tion to a retirement plan or IRA that may
not be claimed as a business expense or
used as an adjustment to offset taxable
income on an income tax return.
Nondiscrimination rules. The provisions in
the U.S. Tax Code that prohibit certain
retirement plans from providing greater
benefits to highly compensated employ
-
ees than to other employees.
Participant, or active participant. An
employee for whom the employer makes
a contribution to the employer’s retire
-
ment plan.

Tax-deductible expense. An item of expense
that may be used to offset income on a
tax return.
Tax deferral. The postponement of tax pay-
ments until a future year.
Vested benefit. The portion of a partici-
pant’s retirement plan accumulation that
a participant may keep after leaving the
employer who sponsors the plan; or the
portion that goes to a participant’s ben
-
eficiary if the participant dies.
1/4 IRAS, 401(K)S & OTHER RETIREMENT PLANS
the money out whenever you want, nor
can you leave it in the plan indefinitely,
hoping, for example, to pass all of the
funds on to your children.
Instead, you must follow a complex set
of rules for withdrawing money from the
plan during your lifetime, and your benefi-
ciaries must follow these rules after your
death. These rules are called distribution
rules, and if you or your beneficiaries don’t
follow them, the government will impose
penalties—sometimes substantial ones.
This first chapter identifies and briefly
describes the types of retirement plans
to which these distribution rules apply. If
you have a retirement plan at work or if
you have established one through your

own business, you should find your plan
listed below. Also, if you have an IRA, you
will find your particular type among those
described below.
There is also an entire category of plans
known as nonqualified plans to which
distribution rules do not apply. Such plans
are used by employers primarily to provide
incentives or rewards for particular—usual
-
ly upper management—employees. These
plans do not enjoy the tax benefits that
IRAs and qualified plans (including TDAs
and qualified annuities) do, and they con-
sequently are not subject to the same dis-
tribution restrictions. Although this chapter
helps you identify nonqualified plans, such
plans have their own distribution rules,
which fall outside the scope of this book.
Identifying your particular retirement
plan probably won’t be as difficult as you
think. This is because every plan fits into
one of four broad categories:
• qualified plan
• IRA
• plan which is neither an IRA nor a
qualified plan, but which has many
of the characteristics of a qualified
plan, or
• plan which is neither an IRA nor a

qualified plan, and which does not
have the characteristics of a qualified
plan.
A. Qualified Plans
A qualified plan is a type of retirement
savings plan that an employer establishes
for its employees and that conforms to the
requirements of Section 401 of the U.S. Tax
Code. Why is it called “qualified”? Because
if the plan meets all of the requirements
of Section 401, then it qualifies for special
tax rules, the most significant of which is
that contributions the employer makes to
the plan on behalf of employees are tax
deductible. Probably the best-known quali
-
fied plan is the 401(k) plan, discussed be-
low in Section 1.
The advantages to you, the employee,
working for an employer with a qualified
plan, are not only the opportunity to ac-
cumulate a retirement nest egg, but also to
postpone paying income taxes on money
contributed to the plan. Neither the con-
TYPES OF RETIREMENT PLANS 1/5
tributions you make nor any of the invest-
ment returns are taxable to you until you
take money out of the plan. In tax jargon,
the income tax is deferred until the money
is distributed and available for spending—

usually during retirement. Congress built in
some safeguards to help ensure that your
plan assets are around when you finally
do retire. For example, the assets are re
-
quired to be held in trust and are generally
protected from the claims of creditors.
In return for these tax benefits, the plan
must comply with a number of procedural
rules. First, the plan must not discriminate
in favor of the company’s highly com-
pensated employees. For example, the
employer may not contribute dispropor
-
tionately large amounts to the accounts of
the company honchos. Also, the employer
may not arbitrarily prevent employees from
participating in the plan or from taking
their retirement money with them when
they leave the company. Finally, the plan
must comply with an extremely complex
set of distribution rules, which is the focus
of this book.
Seven of the most common types of
qualified plans are described below.
1. Profit Sharing Plans
A profit sharing plan is a type of quali-
fied plan that allows employees to share
in the profits of the company and to use
those profits to help fund their retirement.

Despite the plan’s title and description, an
employer doesn’t have to make a profit in
order to contribute to a profit sharing plan.
Similarly, even if the employer makes a
profit, it does not have to contribute to the
plan. Each year, the employer has discre-
tion over whether or not to make a contri-
bution, regardless of profitability.
When the employer contributes money
to the plan on behalf of its employees, the
contributions are generally computed as a
percentage of all participants’ compensa-
tion. The annual contribution into all ac-
counts can be as little as zero or as much
as 25% of the total combined compensa-
tion of all participants. For the purposes
of making this calculation, the maximum
compensation for any individual participant
is capped at $210,000. (The $210,000 in-
creases from time to time for inflation.) No
individual participant’s account can receive
more than $42,000 in a single year. (There
is an exception to the $42,000 limit for in-
dividuals who are older than 50 and who
contribute to a 401(k) plan.)
EXAMPLE: Joe and Martha participate
in their company’s profit sharing plan.
Last year, the company contributed
25% of their respective salaries to the
plan. Joe’s salary was $120,000 and

Martha’s was $190,000. The company
contributed $30,000 for Joe (25% x
$120,000). The company’s contribution
for Martha was limited to the $42,000
ceiling, however, because 25% of Mar
-
tha’s salary was actually $47,500, which
is too much.
1/6 IRAS, 401(K)S & OTHER RETIREMENT PLANS
This year, however, the company’s
profits tumbled, so the company de-
cided not to make any contributions to
the profit sharing plan. Thus, the com-
pany will not contribute any money to
the plan on Joe or Martha’s behalf.
a. 401(k) Plans
A special type of profit sharing plan, called
a 401(k) plan, is named imaginatively af-
ter the subsection of the Tax Code that
describes it. All 401(k) plans allow you to
direct some of your compensation into the
plan, and you do not have to pay income
taxes on the portion of your salary you di-
rect into the plan until you withdraw it.
The plan may or may not provide for
employer contributions. Some employers
make matching contributions, depositing a
certain amount for each dollar the partici-
pant contributes.
EXAMPLE: Fred participates in his

company’s 401(k) plan. His company
has promised to contribute $.25 for
each dollar of Fred’s salary that he
directs into the plan. Fred’s salary is
$40,000. He directs 5% of his salary,
which is $2,000, into the plan. The
company matches with a $500 contri-
bution (which is $.25 x $2,000).
Other employers contribute a fixed per-
centage of compensation for each eligible
employee, whether or not the employee
chooses to contribute to the plan.
EXAMPLE: Marilyn’s salary for the cur-
rent year is $60,000. Her company has
a 401(k) plan which does not match
employee contributions. Instead, the
company contributes a flat 3% of each
eligible employee’s salary to the plan.
Marilyn is saving to buy a house, so
she is not currently directing any of
her salary into the 401(k) plan. None-
theless, the company will contribute
$1,800 (which is 3% x $60,000) to the
plan for Marilyn.
b. Roth 401(k) Plans
Beginning in 2006, employers will be al-
lowed to establish a new type of 401(k)
called a Roth 401(k). This new plan will be
similar to traditional 401(k)s in that it will
allow employees to defer salary into the

plan. The difference will come in the tax
treatment. Whereas contributions to tradi
-
tional 401(k)s are tax deductible, contribu-
tions to Roth 401(k)s will not be. Rather,
the tax benefits for Roth 401(k)s will come
when you take distributions, which will
be tax free as long as you meet certain re-
quirements. Although the IRS has not yet
finalized these requirements, a distribution
likely will be entirely tax free if it occurs
after you reach age 59½ and if you have
had the plan for at least five years.
TYPES OF RETIREMENT PLANS 1/7
2. Stock Bonus Plans
A stock bonus plan is like a profit sharing
plan, except that the employer must pay
the plan benefits to employees in the form
of shares of company stock.
EXAMPLE: Frankie worked for the
Warp Corp. all her working life. Dur
-
ing her employment, she participated
in the company’s stock bonus plan,
accumulating $90,000 by retirement.
When she retired, Warp Corp. stock
was worth $100 per share. When the
company distributed her retirement
benefits to her, it gave her 900 shares
of Warp Corp. stock.

3. Money Purchase Pension Plans
A money purchase pension plan is similar
to a profit sharing plan in the sense that
employer contributions are allocated to
each participant’s individual account. The
difference is that the employer’s contribu-
tions are mandatory, not discretionary.
Under such a plan, the employer promises
to pay a definite amount (such as 10%
of compensation) into each participant’s
account every year. In that sense, money
purchase pension plans are less flexible for
employers than are profit sharing plans.
As with a profit sharing plan, the maxi-
mum amount that an employer can con-
tribute to the plan for all participants
combined is 25% of the total combined
compensation of all participants (although
each participant’s compensation is limited
to $210,000 for purposes of making this
calculation).
The maximum that the employer can con-
tribute to any given participant’s account in
a year is either $42,000 or the participant’s
compensation—whichever is less.
(The $210,000 and $42,000 caps increase
from time to time for inflation.)
EXAMPLE: Sand Corp. has a money
purchase plan that promises to contrib-
ute 25% of compensation to each eli-

gible employee’s account. Jenna made
$45,000 last year and was eligible to
participate in the plan, so the company
contributed $11,250 (25% x $45,000) to
her account for that year. This year, the
company is losing money. Nonethe-
less, the company is still obligated to
contribute 25% of Jenna’s salary to her
money purchase plan account for the
current year.
4. Employee Stock Ownership
Plans (ESOPs)
An employee stock ownership plan, or
ESOP, is a type of stock bonus plan that
may have some features of a money pur-
chase pension plan. ESOPs are designed
to be funded primarily or even exclusively
with employer stock. An ESOP can allow
cash distributions, however, as long as the
employee has the right to demand that
benefits be paid in employer stock.
1/8 IRAS, 401(K)S & OTHER RETIREMENT PLANS
Because an ESOP is a stock bonus plan,
the employer cannot contribute more than
25% of the total compensation of all partic-
ipants and no more than $42,000 into any
one participant’s account.
5. Defined Benefit Plans
A defined benefit plan promises to pay
each participant a set amount of money

as an annuity beginning at retirement.
The promised payment is usually based
on a combination of factors, such as the
employee’s final compensation and the
length of time the employee worked for
the company. If the employee retires early,
the benefit is reduced.
EXAMPLE: Damien is a participant in
his company’s defined benefit plan.
The plan guarantees that if Damien
works until the company’s retire-
ment age, he will receive a retirement
benefit equal to 1% of his final pay
times the number of years he worked
for the company. Damien will reach
the company’s retirement age in 20
years. If Damien is making $50,000
when he retires in 20 years, his retire-
ment benefit will be $10,000 per year
(which is 1% x $50,000 x 20 years). If
he retires early, he will receive less.
Once the retirement benefit is deter-
mined, the company must compute how
much to contribute each year in order to
meet that goal. The computation is not
simple—in fact, it requires the services of
an actuary, who uses projections of salary
increases and investment returns to deter-
mine the annual contribution amount. The
computation must be repeated every year

to take into account variations in invest-
ment returns and other factors and then to
adjust the amount of the contribution to
ensure the goal will be reached.
Even though, under certain circumstances,
defined benefit plans permit much higher
contributions than other qualified plans,
they are used infrequently (especially by
small companies) because they are so com-
plex and expensive to administer.
6. Target Benefit Plans
A target benefit plan is a special type
of money purchase pension plan that
incorporates some of the attributes of a
defined benefit plan. As with a money
purchase plan, each participant in a target
benefit plan has a separate account. But
instead of contributing a fixed percent-
age of pay to every account, the employer
projects a retirement benefit for each em-
ployee, as with a defined benefit plan. In
fact, the contribution for the first year is
computed in the same way a defined ben-
efit plan contribution would be computed—
with the help of an actuary. The difference,
though, is that after the first year, the con-
tribution formula is fixed. While a defined
benefit plan guarantees a certain retirement
annuity, a target benefit plan just shoots for
it by estimating the required annual contri

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TYPES OF RETIREMENT PLANS 1/9
bution in the employee’s first participation
year and then freezing the formula. The
formula might be a specific dollar amount
every year or perhaps a percentage of pay.
If any of the original assumptions turn
out to be wrong—for example, the invest-
ment return is less than expected—the
retirement target won’t be reached. The
employer is under no obligation to adjust
the level of the contribution to reach the
original target if there is a shortfall. Con-
versely, if investments do better than ex
-
pected, the employee’s retirement benefit
will exceed the target, and the increased
amount must be paid to the employee.
EXAMPLE: Jack is 35 when he be-
comes eligible to participate in his
company’s target benefit plan. Jack’s
target retirement benefit is 60% of his
final pay. Assuming Jack will receive
wage increases of 5% each year and
will retire at 65 after 30 years of ser
-
vice, Jack’s final pay is projected to be
$80,000. His target retirement benefit,
then, is $48,000 (60% of $80,000). In
order to pay Jack $48,000 a year for

the rest of his life beginning at age 65,
the actuaries estimate that the com-
pany must contribute $4,523 to Jack’s
account every year. The company will
contribute that amount, even if Jack
doesn’t receive 5% raises some years,
or if other assumptions turn out to be
wrong. Thus, Jack may or may not
receive his targeted $48,000 during his
retirement years. It might be more or it
might be less.
7. Plans for Self-Employed People
Qualified plans for self-employed individuals
are often called Keogh plans, named after
the author of a 1962 bill that established a
separate set of rules for such plans. In the
ensuing years, Keoghs have come to look
very much like corporate plans. In fact, the
rules governing self-employed plans are no
longer segregated, but have been placed
under the umbrella of the qualified plan
rules for corporations. Nonetheless, the
Keogh moniker lingers—a burr in the side
of phonetic spellers.
If you work for yourself, you may have
a Keogh plan that is a profit sharing plan,
money purchase pension plan, or defined
benefit plan. If so, it will generally have
to follow the same rules as its corporate
counterpart, with some exceptions.

B. Individual Retirement
Accounts
Most people are surprised to learn that
individual retirement accounts, or IRAs,
exist in many forms. Most common is
the individual retirement account or in-
dividual retirement annuity to which any
person with earnings from employment
may contribute. These are called contribu
-
tory IRAs. Some types of IRAs are used to
receive assets distributed from other retire
-
ment plans. These are called rollover IRAs.
Still others, such as SEPs and SIMPLE IRAs,
are technically IRAs even though their rules
1/10 IRAS, 401(K)S & OTHER RETIREMENT PLANS
are quite similar to those of qualified plans.
Finally, Roth IRAs combine the features of
a regular IRA and a savings plan to pro-
duce a hybrid that adheres to its own set of
rules. You can learn more about each type
of IRA in the following sections.
1. Traditional Contributory IRAs
If you have income from working for
yourself or someone else, you may set up
and contribute to an IRA The IRA can be
a special depository account that you set
up with a bank, brokerage firm, or other
institutional custodian. Or it can be an indi

-
vidual retirement annuity that you purchase
from an insurance company.
You may contribute a maximum of
$4,000 for 2005 ($4,500 if you will reach
age 50 by the end of the year). If you are
not covered by an employer’s retirement
plan, you may take a deduction on your
tax return for your contribution. If you are
covered by an employer’s plan, your IRA
might be fully deductible, partly deduct-
ible, or not deductible at all depending on
how much gross income you have.
For example, in 2005, if you are single
and covered by an employer’s plan, your
contribution is fully deductible if your
adjusted gross income, or AGI, is less than
$50,000 and not deductible at all when
your AGI reaches $60,000. Between $50,000
and $60,000 the deduction is gradually
phased out. For married individuals, the
phaseout range is from $70,000 to $80,000,
if the IRA participant is covered by an em-
ployer plan. For an IRA participant who is
not covered by a plan but whose spouse is
covered, the phaseout range is $150,000 to
$160,000.
EXAMPLE 1: Jamie, who is single and
age 32, works for Sage Corp. and par-
ticipates in the company’s 401(k) plan.

In 2005, he made $20,000. Eager to
save for retirement, Jamie decided to
contribute $4,000 to an IRA. Since his
income was less than $50,000, Jamie
may take a $4,000 deduction on his
tax return for the IRA contribution,
even though he also participated in his
employer’s retirement plan.
EXAMPLE 2: Assume the same facts as
in Example 1 except that Jamie’s salary
was $70,000 in 2005. Although Jamie is
permitted to make an IRA contribution,
he may not claim a deduction for it on
his tax return because his income was
more than $60,000.
EXAMPLE 3: Assume Jamie made
$75,000 in 2005, but Sage Corp. did
not have a retirement plan for its em-
ployees. Because Jamie was not cov-
ered by an employer’s retirement plan,
his $4,000 IRA contribution is fully
deductible even though he made more
than $60,000.