Tax laws provide for plans that allow self-employed individuals to establish retirement plans for themselves and their employees, if they have any. Those most frequently encountered are the SEP (Simplified Employee Pension) and Keogh Profit Sharing Plans. Even though they are not IRAs, the SEP plans utilize an IRA account as the depository for the SEP plan contribution, thus minimizing the administration requirements of the employer.

The compensation limits for both of these plans is generally 25% of compensation. The following details the differences between contributions for employees and the amount allowed for the self-employed individual.

• Employees: Contributions in 2010 and 2011 on behalf of an employee are generally limited to the lesser of $49,000 or 25% of the employee's compensation (up to the compensation limit). The compensation limit for 2010 and 2011 is $245,000.
  
  
• Self-Employed Individual: The contribution limit is 25% of the net profits from self-employment (20% of the net profits before deducting the contribution itself). The contribution is also limited same maximum contribution amount and compensation limits as the employee.
  
  Both the compensation limit and the annual contribution limit are adjusted annually for inflation.

Many employers offer what are commonly referred to as 401(k) plans, named after the tax code section that created the plans. These plans allow employees to defer part of their earnings for retirement. Some employers offer matching contributions that increase the attractiveness of the programs.

The value of 401(k) plans is enhanced even further by increasing the general contribution limit and allowing individuals over age 50 to make additional contributions. Where an employers plan permits, individuals can contribute amounts that are not excluded from income to a 401(k) plan in a manner similar to Roth IRA contributions.

Catch-up contributions are exempt from the regular dollar limits on deferrals provided that all 401(k) plan participants are permitted to make catch-up contributions.

The table below summarizes the inflation adjusted limits for 401(k) plans for 2009 through 2012. If you have additional questions about participating in your employer's 401(k) plan, please call this office.

Your age at the time you make a taxable withdrawal from your Traditional IRA account can make a big difference in the amount of tax you will pay. Generally, there are three periods within your lifetime where different tax rules apply:

• Under Age 59 - If you withdraw the IRA funds before you reach age 59, you will pay tax and a 10% early withdrawal penalty unless you can avoid the penalty through one of the several exceptions provided in the tax law. Note: Some states also have small early withdrawal penalties.
  
  
• Age 59 to Age 70 - During this period you can make withdrawals of any amount without penalty. You are only subject to the income tax.
  
  
• Above Age 70 - After reaching age 70, you must begin taking at least the required minimum distributions or face the 50% excess accumulation penalty.

The number one key to minimizing taxes on IRA distributions is to match withdrawals to tax years in which you are in a low tax bracket or even have a negative taxable income. Take for example a year when because of illness, disability, unemployment, large business losses etc. that your income, less your deductions and personal exemptions, leaves you with a negative taxable income for the year. To the extent your taxable income is negative, you could make a taxable IRA withdrawal and avoid any tax on the amount withdrawn, and even if you are under 59, you would only pay the small early withdrawal penalty.

Generally, except as mentioned above, if you are under 59, your IRA funds are not a good source of cash except in cases of extreme need simply because of the tax liability and penalties. But if there are no alternatives, it may be possible to avoid part or all of the penalties by carefully planning the withdrawals so that they qualify for one or more of the early withdrawal penalty exceptions; (1) amounts withdrawn to pay un-reimbursed medical expenses, (2) amounts withdrawn while qualifying as disabled, (3) amounts withdrawn and used to pay for medical insurance while unemployed, (4) amounts used to pay higher education expenses, (5) amounts up to $10,000 for the purchase a first home, and (6) early retirement amount withdrawn as an retirement annuity. Taxpayers must meet certain criteria to qualify for these exceptions, so be sure to contact this office to make sure you meet those qualifications before proceeding.

For retired individuals, receiving Social Security benefits, planning IRA distributions can also be beneficial. Social Security itself is only taxable when the taxpayer's Social Security benefits added to the taxpayer's other income exceeds $25,000 ($32,000 for a married couple filing jointly). Once this threshold is reached, every additional dollar of other income will cause 50 to 85 cents of the Social Security benefits to also become taxable. Therefore, if a taxpayer's other income is under the threshold, it is generally good practice to withdraw just enough taxable IRA funds to bring the income up to the threshold amount even if the funds are not needed in that year. They can be set-aside for a future year when they might be used for some unplanned need or large purchase. Retirees, with income that already puts them over the Social Security taxable threshold, should avoid large uneven withdrawals that might push them into a larger tax bracket one year and way below that tax bracket change in other years.

Remember, once a taxpayer reaches 70, they must begin taking distributions equal to or greater than the Required Minimum Distribution, somewhat limiting planning options. If you wish to explore any of these or other tax saving techniques, please contact this office.