IRA / 401(k)'s

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What are IRA's and 401(k)'s? In Canada we have company pension plans for employees, and RSP's (Retirement Savings Plans) for the self-employed. My wife and I fall in the latter category.

Almost all of our liquid assets are in RSP's. If we withdraw funds from our RSP's (which we are about to do), and we do it in chunks of $5,000, there is a 10% withholding tax, which increases on a sliding scale for larger amounts taken out. At the end of the year, everything that was withdrawn during the year gets taxed as income anyway, so as much as 50% would be lost.

Is this similar to the US? Just wanted to get a picture of what we are all up against. Thanks.

Steve Francis

-- steve francis (sfrancis@sympatico.ca), April 20, 1998

Answers

Steve, a 401(k) plan in the U.S. is a company retirement plan funded partially or wholly by the employee, sometimes with matching funds from the employer. The employee's contributions are exempt from income tax, although they are subject to Social Security and Medicare taxes of approximately 7.5% by the employee and a matching amount of tax by the employer. The employee may put in amounts up to roughly 20% of earnings with a maximum annual contribution amount which changes each year with inflation but which I believe was about $9,500 in 1997. The employer may have rules about when you can withdraw money from the plan, but the Internal Revenue Service also has rules. Money withdrawn from the plan is subject to ordinary income tax at the time of withdrawal. In addition, if the employee is less than 59 and a half years old at the time of withdrawal, there is an income tax surcharge of 10% of the amount withdrawn. Most people would be in either the 15% or 28% tax bracket on withdrawals, not counting the possible 10% penalty. (Sounds very similar to the Canadian tax rules, although American tax rates are generally lower than Canadian tax rates).

An Individual Retirement Account (IRA) is a personal retirement account, not through an employer (unless it is something called a SEP-IRA), usually at a broker or bank. Generally you can only contribute to an IRA account if you do not have a company pension plan. There is a limitation of $2,000 per year contribution, which can be deducted from your income before calculating your income tax. Withdrawal provisions and penalties are similar to the 401(k). Naturally, since these are part of the tax structure, there can be further complexities, but I believe this gives a reasonable overview.

It may be worth noting that I believe that you can hold gold in pension accounts if it is in the form of American Eagle gold bullion coins. Perhaps someon

-- Dan Hunt (dhunt@hostscorp.com), April 20, 1998.


My husband, whom I lovingly call Butch, tried to withdraw money from his 401k and was told that there was 3 ways he could get the money. 1. he could quit. 2. he could get fired. 3. he could borrow 1/2 of the amount and then pay it back at 10% interest. Do you have any advise on what to do? Thanks , Anita

-- anita ray (aray@mindspring.com), April 22, 1998.

Anita,

Option 1 sounds good, after a new job is found, of course. If Butch is less than 59 1/2 they will probably withhold 20% for the IRS, but 80% is much better than 0.

George

-- George Valentine (georgevalentine@usa.net), April 23, 1998.


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