Hi,

I have two questions:

1) How does the self-employed pension work, in terms of funding it, investing it, and withdrawing from it?

2) Currently, how are the different retirement vehicles (401k, Roth IRA, self-employed pension, Social Security, taxable accounts) taxed upon retiring? My understanding: taxable accounts are taxed at 15% capital gains and do not count as income. 401k as income. Roth IRA tax-free and not as income.

Thanks!

Great questions. It seems like you are really trying to get a jump on your savings.

When you're self-employed, you establish and contribute to a retirement plan on your behalf, and then you manage the money that has been contributed. You are also responsible for distributing the money from these accounts at the appropriate times.

The three most popular retirement plans for self-employed inviduals are SEPs, SIMPLEs, and Solo 401k's. I wrote about these three options at: http://www.mdtaxes.com/news0706.html, and then wrote about the updated retirement limts for 2009 at: http://www.mdtaxes.com/news1108.html#2.

With respect to your other question:

Contributions into traditional 401(k)s and self-employed retirement plans are tax-deductible, these accounts grow tax-deferred, and you pay taxes on any money withdrawn down the road.

Contributions into Roth accounts are NOT tax-deductible, grow tax-deferred, and then any withdrawals are NOT taxable as long as certain conditions are met.

Finally, you don't claim deductions for money invested within a taxable account. And you pay taxes on any investment income earned over the years. The top capital gains rate for investments held for more than one year before being sold is 15%. The same top rate applies to corporate dividends.


I think this answers your questions.

Zip Code: 01801

Medical Resident-

You should also note that withdrawals from a 401(k), 403(b), SEP and Traditional IRA are not taked at the capital gains rate. These withdrawals are taxed as ordinary income.

There may also be penalties if monies are withdrawn prior to age 59.5.

Larry

Zip Code: 11050

Thank you for getting back to me. I am trying to understand how to optimize my taxable income during the withdrawal phase of retirement.

If I understand correctly, here is a scenario:

ASSETS AT RETIREMENT:

401k-like funds = $2,000,000
Taxable savings = $2,000,000
Roth IRA = $300,000
Personal pension = $50,000/year

INCOME AT RETIREMENT:

401k-like funds = withdrawals taxed at marginal rate (33% over $200k/year married)
Taxable savings = withdrawals taxed at capital gains rate (15% now)
Roth IRA = not taxed
Personal pension = withdrawals taxed at marginal rate

So, if my two goals were to 1) stay at 28% marginal (i.e., under $200k/year married) but 2) withdraw >$200k/year, I would take $50k from the pension, then $150k from the 401k-like vehicles. Beyond that, I would take from either the Roth or taxable account.

Is this correct? Thanks and happy holidays!

Medical Resident-

While what you are saying makes sense today, this may not hold true in the future - especially with social security's future up in the air, the deficit, the war on terror and the endless bailout plans.

The best thing to do is establish a series of short term strategies that will ultimately become your long-term strategy.

As a resident, I think you are getting way ahead of yourself thinking about the distribution phase of financial planning.

At this point, your focus should really be to protect your income (with a high quality "Own-Occupation" disability policy, purchase term life insurance to protect your family as well as your ability to buy life insurance, establish a Roth IRA and contribute to a 403(b) plan and/or SEP plan for moonligting income, if any.

Additionally, if you are married and have children, you should see an attoney to draft a will, health care representative power of appointment, a durable power of attorney and a living will.

Hope this helps. If you want to discuss your situation in more detail, feel free to call or visit my website (www.physicianfinancialservices.com) where you can read many of my "Disability Insurance and Financial Planning Articles for Physicians". I think you will find them very informative.

Also what do you mean by personal pension plan?

Larry

Zip Code: 11050