Retirement planning in 2021 can seem more complex, especially with the ever-changing legislation. Health costs have gone up, and Social Security is uncertain. There could be significant cuts in the Federal Medicare budget soon.
If you have a retirement plan, it’s essential to understand how much you can contribute, when you can take money out, and the taxes you’ll incur when doing so. Although there are Federal laws and regulations for retirement plans, there are many different plans.
To understand the details of your employer’s plan, ask your human resources specialist for a copy of the Summary Plan Description.
Defined Benefit Plans vs. Defined Contribution Plans
Employer-sponsored retirement plans can be defined contribution plans or defined benefit plans. Defined contribution plans make up individual accounts for each participant.
The participant makes contributions to the plan. The participant invests in these contributions. At retirement, the benefit’s value equals the amount of money contributed plus the performance of the investments. Defined benefit plans do not involve separate accounts for participants.
Instead, these types of plans promise a specific amount at retirement. Defined contribution plans have increased in popularity in the past few decades.
They have become many times more common than defined benefit plans. If you have a 401(k) through your employer, it is a type of defined contribution plan.
Defined contribution plans make up of various sources of funds contributed by the employee or employer. The specific design of the program determines these sources.
A plan might allow for standard, pre-tax employee contributions or offer a Roth deferral option. Roth refers to after-tax contributions, where since you pay taxes going in, you don’t pay taxes when the funds come back to you.
An example of an employer contribution source would be matching contributions. Matching contributions mean that the employer matches your contribution up to a certain percentage of your salary.
It’s a good rule of thumb to contribute at least the amount that your employer matches when possible.
2021 Contribution Limits and Catch-Up Contributions
“Elective deferrals” are money that you, the participant, contribute to your defined contribution plan as a dollar amount or percentage of your salary from each paycheck.
The contribution limit for 401(k), 403(b), and most 457 plans are $19,500. If you have reached age 50 by the end of the calendar year, you may also contribute catch-up contributions. The limit for these additional, catch-up contributions is $6,500. These contributions are allowed in 401(k) (not SIMPLE), 403(b), SARSEP, or governmental 457(b) plans. The limit for catch-up contributions has increased.
Required Minimum Distribution Age
If you turn 72 and have funds in an employer retirement plan, you must adhere to the Required Minimum Distribution. Meaning, you need to start taking funds out. In January, the age for Required Minimum Distributions saw an increase. For those who turned 70 ½ before the first of the year, the previous age still applies.
Required Minimum Distribution refers to the least amount you must start withdrawing from your plan annually. You can withdraw more than this amount if you wish. The determination amount comes from your age and account balance. If your spouse is more than ten years younger than you and is your sole beneficiary, their age is also a factor.
It’s important to remember to take your RMD each year in its entirety to avoid having to pay a 50% excise tax. You must take your first RMD by April 1st of the year you turn 72.
Early Distribution Tax
If you withdraw funds from your retirement account before the age of 59 ½, you will be subject to an additional 10% tax.
A few exceptions exist for this tax, including:
- Disability of the participant
- Certain unreimbursed medical expenses
- Military reservist requesting a qualified distribution after a calling for active duty
If the employee separates from service after they turn 55, they are also not subject to the early distribution tax.
Planning Retirement Distributions
The Normal Retirement Age or Normal Retirement Date is established by the plan documents for a defined contribution plan. This cannot be later than when the participant reaches 65 years of age.
Sixty-five is also most often the participant’s age at which the value for defined benefit plans is calculated.
When the participant reaches their plan’s Normal Retirement Age or Normal Retirement Date, they have the option to receive their benefit in full. In the case of defined benefit plans, the benefit is received in installments.
As Roth deferrals are taxed when they are contributed to the account, no tax is deducted from the retirement benefit taken from a Roth account.
Funeral Expenses to think about while Planning Retirement
You want to set up final arrangements when you’re making your retirement plan. While this is for your loved ones more than it’s for you, it’s still important. When doing this you’ll want to consider your life insurance, assets, and power of attorney. Since Medicare doesn’t consider a funeral a medical expense, you’ll need to make sure your family can cover the cost.
Retirement Planning in 2021
Often, we enroll in the retirement plan that our employer offers as soon as possible. We seldom reevaluate how much we are contributing to the plan throughout the years. If you wish to retire in the not-too-distant future, it is vital to stay aware of the latest updates in retirement planning. A retirement checklist will help ensure your financial security in retirement. It is beneficial to be aware of the current limits for retirement plans. Ages 59 ½ and 72 are also important to keep in mind, so you’re not in shock over additional taxes.
Make sure you are familiar with the specifications of your retirement plan and take time to look over the plan documents.