Pension rules are extremely complicated, and learning them sufficiently requires years in school for most accountants. Even though you may not fully understand pension rules, you can still educate yourself enough to make an informed decision about the best option for your retirement. Whether you choose an IRA, a 401k or other pension form, you should elect the option that makes the most sense for your personal financial goals.
Basic Pension Rules
Pension is a broad term for any retirement savings account. Pension funds were created as a special provision in the tax code to encourage saving. Pensions encourage saving by offering some tax-free alternatives to other investment forms. When you elect a pension, you will be gaining tax benefits of some type, but the exact benefit relies on the type of pension you elect. Basic rules for any pension, though, govern how much you can contribute, what portion of contributions is deductible or tax free, the taxes you will pay on investment earnings and when and how you can withdraw the funds. Failure to meet these requirements will result in penalties or loss of tax benefits.
Basic IRA Rules
IRA funds, or Individual Retirement Accounts, offer tax deductible contributions. This means you can contribute funds up to a certain amount each year, typically a percentage of your income underneath an annual maximum, and then subtract those contributions from your yearly taxable income. Further, once the funds are in the IRA, they will be able to grow tax free. An IRA administrator will invest the funds for you, and at times this is done at the corporate level. Once you reach the age of 59 1/2, you will start to receive withdrawal options and annuities from your IRA. If you take money out before then, you will have to pay a penalty. When you withdraw funds, you will have to pay taxes on those funds.
Roth IRA Rules
Roth IRAs are different from traditional IRAs. Roth plans are aimed at low income persons who are contributing a small amount into an account each year. They were created to encourage even low income or young persons to start saving for retirement. They allow a person to pay taxes on the contribution only once. Then, the funds grow tax free. When the funds are withdrawn, taxes are already considered to have been paid, so the person is not taxed again. This offers a large advantage to young persons who are at a low tax bracket initially. They have the option to save funds now that are taxed only at their low income bracket then withdraw them when they are likely to be at a much higher level.
Other Rules to Be Aware Of
Early withdrawals are penalized at a rate of 10%. You may be eligible for a loan against your pension if your employer is willing to extend this option. You may also be able to switch between pension options before a pension has matured, but this is subject to a high amount of regulation and should be done under the care of an adviser.