Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy from benefiting more than the average worker.

Contributions to traditional IRA and 401(k) accounts are made with pretax dollars, so they can offer a significant reduction to a worker’s annual income tax burden. The contributions to many retirement savings accounts are capped to ensure that those who can afford to defer large amounts of their compensation do not take advantage of this tax benefit.

401(k) Contribution Limits

In 2017, the maximum employee contribution to a 401(k) plan, either traditional or Roth, is $18,000.Also, employers can contribute through either non-elective deferrals or contribution matching. However, the total contribution from all sources must not exceed the lesser of the employee’s compensation or $54,000 for 2017.

To encourage those nearing the end of their working years to contribute more, the IRS also allows additional catch-up contributions for employees over the age of 50. In 2017, the catch-up contribution is $6,000, for those over 50.

Non-Discrimination Testing

A 401(k) is a qualified retirement plan offered through an employer. The IRS imposes certain limitations on the contributions of highly compensated employees, called non-discrimination testing, to encourage equal participation across all compensation levels.

For the 401(k) plan to retain its qualified status, contributions made by employees who earn large salaries – more than $120,000 must not exceed a certain percentage of the average contribution made by non-highly paid employees. This prompts higher-level employees, such as executives and management, to encourage plan participation among the rank and file. As the average regular employee contribution increases, the amount that more highly compensated employees are allowed to contribute increases, up to the annual maximum.

IRA Contribution Limits

For the 2017 fiscal year, IRA participants are limited to a maximum contribution of $5,500, or 100% of their compensation, whichever is lesser. Those over 50 can make catch-up contributions of up to $1,000 annually.

Like 401(k) plans, the contribution limits for IRAs apply to all accounts held by the same person. If you have both a traditional IRA and a Roth IRA, the total of all your contributions to both accounts cannot exceed $5,500, or $6,500 if you are over 50.

Leveling the Playing Field

IRAs are not qualified retirement plans because they are not offered through an employer. There is no provision for the type of non-discrimination testing that applies to 401(k) contributions.

However, IRAs were developed to encourage the average worker to save for retirement and not as another tax shelter for the rich. To prevent unfair benefit to the wealthy, the amount of your contribution to a traditional IRA that is tax-deductible may be reduced if you or your spouse is covered by an employer-sponsored plan, or if your combined income is above a certain amount.

In addition, Roth IRAs are only available to those who meet certain income requirements. In 2017, the contribution limits for single persons who earn more than $118,000, and married couples filing jointly who earn more than $186,000, are reduced. Individuals who earn more than $133,000 and couples who earn more than $196,000 are not eligible to contribute to Roth IRAs.

Your employer or the plan administrator for the 401(k) plan should have provided you with a copy of the 401(k)’s summary plan description (SPD).

If you can’t find your copy, contact your employer and ask for a replacement. A copy of the plan’s SPD may also be obtained from the Department of Labor (DOL) by writing to: The Department of Labor, EBSA, Public Disclosure Room, Room N-1513, 200 Constitution Avenue, N.W., Washington, D.C.20210. (They may charge you copying fees, which are usually a very small amount.)

The SPD is required to include an explanation – in non-technical terms – of the plan provisions, such as your benefits and rights under the plan, including when you are eligible to receive distributions.

Alternatively, you may ask your employer to provide an explanation for refusing to honor your request; in fact, you must be given an explanation in writing. Legitimate explanations for a delay in distributions include the following:

• You are not yet eligible. For instance, the plan may require that participants reach a certain age before they are considered eligible to receive a distribution. This age requirement can apply even if you are no longer employed with the company.
• The plan may make payments only at a certain frequency, such as quarterly. Therefore, if you requested a distribution in mid-January, you may need to wait until March 31 before you receive the requested amount.

If you feel your employer is not complying with the terms of the plan, you may contact the DOL toll free at 1-866-444-3272 and ask to speak with a regional office representative near you, or you may contact your regional office.

(See What information does my employer have to give me regarding my 401(k) plan?)

401(k) plans are not FDIC-insured because they are typically composed of investments rather than deposits. The Federal Deposit Insurance Corporation (FDIC) covers deposits, not investments. Investments are riskier and carry the potential for loss of principal. Most 401(k) accounts are composed of investments. However, bank deposits in a 401(k) account are covered by the FDIC, as are funds held in money market accounts.

The FDIC protects bank accounts up to $250,000. This insurance on bank deposits was introduced in the early part of the 20th century to end bank runs and increase confidence in the financial system.

Faith in the System

Banks are at the heart of a successful capitalist economy. Faith and confidence in the banks’ ability to make good on customer deposits is a necessary ingredient for credit creation. Depending on interest rates and economic conditions, banks give out a certain percent of loans against these deposits. However, this would not be possible if customers pull their money from banks at any moment they feel uncertain.

The FDIC was created in 1933 under President Franklin Delano Roosevelt as a remedy to the bank runs, which were exacerbating the Great Depression and hindering any sort of recovery. Basically, banks pay into a fund. The fund pays for oversight of the banks and is used to compensate deposit holders if a bank goes under. The net result is fewer bank failures, due to the regulatory oversight and confidence that deposits are safe. Since its inception, no FDIC member bank has lost any customer deposits.

Investments Not Covered

Unfortunately, it is not possible to apply the same protection to 401(k) accounts, as they are full of riskier investments. If the FDIC were to begin insuring investments in 401(k) accounts, it would lead to excessive risk-taking and distortion of asset prices. This would undermine one of the primary mechanisms of financial markets – price discovery.

However, the FDIC does insure safer assets held in 401(k) accounts, such as bank deposits and money market funds. For example if a 401(k) account, worth $100,000, has 50% invested in stocks, 25% in bonds and 25% in money market accounts, then $25,000 of the 401(k) is covered by the FDIC in the event of some catastrophe in which the banking institution goes under.

Practicality

It simply is not practical for the FDIC to cover the entire spectrum of possible investments in a 401(k) account without imposing draconian restrictions on the type of investments that can be made. The budget and credit line for the FDIC would have to be dramatically increased for it to have the resources to insure against these investments. While customers can trust their banks as long as they are FDIC-insured, they must do due diligence when making their own investments to find the optimal balance between risk and return.

On August 14, 1935, U.S. President Roosevelt signed into law the Social Security Act.Originally implemented to assist older Americans by paying them a continuing income upon their retirement, the program was later amended to extend benefits to the spouse and minor children of retired workers, workers who become disabled, families in which a spouse or parent dies and, more recently, health coverage (Medicare).

The Social Security program is funded through the Federal Insurance Contributions Act (FICA) tax, a dedicated payroll tax. You and your employer each pay 6.2% of your wages, up to the taxable maximum of $128,700. If you are self-employed, you pay the entire 12.4%; however, you can deduct half of the self-employment tax as a business expense. Under the law, Social Security is financed by this designated tax, and any surplus money that isn’t paid out in benefits is used to buy U.S. government bonds held in the Social Security Trust Fund.

The money that you pay through taxes is not the same money that you will receive later in life. Instead, Social Security is primarily a pay-as-you-go system, where the money you and your employer contribute now is used to fund payments to people who currently receive benefits, including those  who have retired or are disabled, survivors of workers who have died, dependents and other Social Security beneficiaries.

The Problem

So what’s the problem? Basically, demographics.

Americans are having fewer children and living longer, both of which contribute to an aging population. Baby boomers (those born between 1946 and 1964) are retiring at a record pace: 14% of the population is age 65 (the earliest retirement age at which you can collect full benefits) and over, and by 2080, it will be 23%. At the same time, the working-age population is getting smaller, from about 60% today to 54% in 2080.

These trends result in declining worker-to-beneficiary ratios: As we move forward, there will be fewer people putting money into the Social Security system and more people taking money out. Because of these factors, it has been estimated that all the money in the Social Security “bank account” will be exhausted in 2035, when it will have only about 77% of what it should pay out that year. That means that without any changes to the system, if you’re in your forties or fifties today, you could conceivably not receive Social Security benefits during retirement, even though you’re paying into the system now. 

But that’s a worst-case scenario. Social Security is nowhere near bankruptcy, and it has nearly two decades to act before funds are completely depleted. Increased taxes, benefit cuts, and upping the age at which people can start collecting benefits (or a combination of these) are all changes that could be implemented to make up any future shortfalls; in fact, the age at which workers are eligible for full benefits has already started creeping up from 65 to 67, depending on one’s birth year.

For a more detailed discussion, see How Secure Is Social Security?

As the most widely used and well-known retirement savings plans in the United States, 401(k) plans were the brainchild of benefits consultant Ted Benna. In 1980, Benna noticed that the rules established in the Revenue Act of 1978 made it possible for employers to establish simple, tax-advantaged savings accounts for their employees.

History

The term “401(k)” refers to Section 401(k) of the Internal Revenue Code. The provision allows employees to avoid taxation on parts of their income if they elect to receive it as deferred compensation rather than as direct pay.

However, the original provision did not allow for a separate account to be set up and funded through salary reductions. Benna petitioned the IRS to modify Section 401(k), which was written as part of the Revenue Act, and in 1981 the IRS complied. By the next year, several large companies began to offer new 401(k) plans to employees. Participants in 401(k) plans could then use their deferred income to make investments without being taxed on gains.

These new accounts quickly became popular. In 1983, more than 7 million employees participated in a 401(k) plan. By 1991, that number had reached 48 million, and the combined assets of all 401(k) plans surpassed $1 trillion in 1996.

In 2001, the United States Congress passed the Economic Growth and Tax Relief Reconciliation Act, which allowed for the so-called “catch-up contributions” for participants age 50 and older. The Act also allowed for companies to offer Roth 401(k) accounts, which require post-tax contributions but provide the benefit of tax-free growth and distribution.

Purpose and Uses

Modern 401(k) plans were not an intentional design of the U.S. government or the Internal Revenue Service. Indeed, the federal government twice tried to invalidate 401(k) plans in the late 1980s. The concern was that tax receipts would fall too fast as more workers funded their retirement plans.

Employees receive two significant benefits from 401(k) plans and other tax-exempt retirement accounts: first, there is the obvious tax benefit. Second, employees have a way to protect their retirement savings from losing real purchasing power through inflation. On the downside, 401(k) plans are more risky for employees than defined benefits plans, which are federally guaranteed.

There are obvious benefits to employers as well. For instance, the costs of offering retirement benefits have declined significantly. Small businesses particularly benefit from the new defined contribution plans; the plan allows these businesses to offer similar benefits packages to employees as those found in larger companies, leveling the playing field.

The federal government encourages the use of 401(k)s and other retirement plans. Even though tax receipts decline as more people participate, a population that funds its own retirement ends up reducing government expenditures on welfare programs for the elderly.

• Retain the assets in the SEP IRA
• Transfer the SEP IRA balance to a Traditional IRA or another SEP IRA
• Roll over the balance to a qualified plan, 403(b) or 457(b) account in which the individual participates

To read more, see the SEP IRAs tutorial.

This question was answered by Denise Appleby
(Contact Denise)

In general, the Social Security Administration, or SSA, does not encourage citizens to change their Social Security numbers, or SSNs. However, exceptions are made under certain circumstances. Victims of identity theft or abuse are the most likely candidates for new numbers.

Identity Theft

Identity theft is one of the fastest-growing crimes worldwide. In addition to trolling the Internet for unguarded information, thieves can obtain your SSN and other personal details by going through your trash, stealing your wallet, or contacting you by phone or email posing as an employer, bank employee or insurance agent.

Once your identity is stolen, it may not be possible to truly get it back. If someone manages to steal your SSN, he can easily use it to obtain other information about you, such as your name, birthday and credit information. Armed with this knowledge, a criminal can simply open up any number of new credit cards under your name, use them until the credit limits are met and then never repay the debts.

Often, a person does not know his identity has been stolen until he begins receiving calls from creditors or is turned down for a loan due to a bad credit score. In some cases, the damage is irreparable.

Harassment and Abuse

Sometimes it becomes necessary for a person escaping a violent relationship or other life-threatening situation to shed a previous identity to protect himself. Victims of domestic violence and stalking, or those who are under threat of physical harm, often must choose between the stress of starting over and the fear of staying put. The SSA does not normally issue new SSNs but does so to assist those whose safety is in danger.

Other Reasons

Of course, there are other reasons a person might want to change his SSN that are much less serious. The SSA may approve a change if similar numbers within a family unit cause confusion, for example, or if two identical numbers have been issued in error. If you have a religious objection to a certain number or sequence of numbers within your current SSN, you may also qualify.

Not So Fast

The SSA does not provide replacement numbers for those who are attempting to avoid the consequences of bankruptcy or are evading the law. In addition, you will not be issued a new number if you have lost your Social Security card but there is no evidence your number is being used by someone else.

Changing Your Social Security Number

To change your SSN for any reason, you must apply in person at any Social Security office. After providing a statement explaining why you need a new number, you must provide credible, third-party documentation of your reason, including medical, legal or police documents regarding any identity theft, abuse or harassment. In addition, you must provide documentation of your U.S. citizenship or legal residency, age, identity and current SSN. If you have custody of any children or changed your name in the past, supporting documentation must also be provided. Specific guidelines apply regarding acceptable sources and types of documentation.

The current Social Security system in the United States operates in a pay-as-you-go framework; the Social Security taxes paid by today’s workers enter the general fund and are immediately used to pay for current claimants. Privatization would eliminate the pay-as-you-go process. Instead, each taxpayer’s individual contributions would be invested into a separate account for his own retirement.

Proponents of privatization claim that the current system generates insufficient returns, acts like a Ponzi scheme and that a private system would result in higher standards of living for participants. Those who oppose privatization counter that it would lead to unwanted investment risk, and that it would be too difficult to move from the old system to a new one.

Today’s Social Security System

Social Security has come under increasing scrutiny because of its pending insolvency. Too many retirees are living for too long; current workers are not making enough payments to keep the program running.

When Social Security was implemented in the 1930s, the average life expectancy in the U.S. was 58 for men and 62 for women. Only 54% of men who reached age 21 would live to age 65, when it would be possible to collect Social Security benefits, according to the Social Security Administration (SSA). By 1930, there were only 6.7 million Americans 65 or older.

Today, there are more than 40 million Americans who are past retirement age. The average remaining life expectancy for those who reach age 65 is nearly 20 years. Moreover, the value of a Social Security benefit has been hard hit by inflation. Even with consumer price index (CPI) adjustments to their benefits, American seniors lost 34% of their buying power from 2000-2012.

How Privatizing Would Work

Privatizing Social Security would allow a worker’s salary contributions – which would likely still be mandatory at 12.4% – to be deposited into private investment companies or public-private management funds. Workers would have the option to increase their contributions to retire earlier or to increase their payouts in retirement.

At retirement, the worker would also likely be able to choose from several different payout options that are found in the private sector, such as annuity or life payments. In fact, this very system has been running in Chile since May 1, 1981.

The Chilean government had a pay-as-you-go system in place prior to 1981, but budget shortfalls led to a revolution in late-age retirement savings. By linking benefits to contributions on an individual basis, the Chilean workers have been able to realize an average annual rate of return that exceeds 9%; the U.S. Social Security system theoretically pays a 1% to 2% rate of return.

Even when accounting for risk-adjusted return, the privatized system in Chile offers hope that privatized retirement savings could help retirees and reduce the national debt at the same time.

If you decide to leave the company that holds your 401(k) plan, you have four options for dealing with your funds, and the tax implications depend on which option you choose. These options include:

1. Leave the money with your old plan (if eligible).
2. Move the money to a new employer’s plan (if eligible).
3. Move the money into a rollover IRA.
4. Cash out the 401(k), taking a distribution.

The rules are also different if you have borrowed from your 401(k) and leave your job prior to repaying the loan.

1. Leave the Money Alone

There are no real tax implications for leaving your 401(k) funds parked in your old employer’s plan. Your money remains and grows tax-exempt until you withdraw it. The plan is not required to let you stay if your account balance is relatively small (less than $5,000), but the company that holds the plan assets generally allows participants to roll the 401(k) plan assets into a traditional IRA within the company.

However, you won’t be able to make additional contributions to the plan. And because you are no longer an employee plan participant, you may not receive important information about material changes to the plan or its investment choices. Also, if you elect to leave your funds with your old plan and then later attempt to move them, it may be difficult to get your old employer/plan provider to release the funds in a timely manner.

2. Move the Money to a New Plan

You are not required to pay taxes on your 401(k) nest egg if you move it into a new plan. One caveat: While 401(k) funds are eligible under ERISA to be transferred from one plan to another, but 401(k) plans are not required to accept transfers. Your eligibility to pursue this option depends on your new company’s plan rules. Additionally, things can be tricky if the new plan is not a 401(k), as not all defined-contribution plans are allowed to accept 401(k) funds.

3. Establish a Rollover IRA

If you don’t have the option to transfer to another employer-sponsored plan, or you do not like the fund options in the new 401(k) plan, establishing a Rollover IRA for the funds is a good alternative. You can transfer any amount, and money continues to grow tax-deferred. It is important, however, to elect to perform a direct rollover. If you take control of your 401(k) funds in an indirect rollover, your old employer is required to withhold 20% of it for federal income tax purposes, and possibly state texes as well.

4. Cash Out and Take a Distribution 

You will pay income taxes at your current tax rate on distributions from your 401(k). Plus, if you are under the age of 59½, your distribution is considered “premature,” and you’ll lose 10% of it to an early withdrawal penalty.

The Bottom Line

If you have an existing 401(k) loan, regardless of the above options you elect when you quit your job, all outstanding 401(k) loan balances must be repaid (usually by the October of the following year, the deadline to file extended tax returns). Any money not repaid is treated as an early withdrawal by the IRS and you pay taxes on the amount in addition to being hit with the early withdrawal penalty.

When filing your tax return, you are generally required to include the social security numbers of yourself and the individuals for whom you claim as dependents. However, exceptions do apply.

Exceptions
Child Born and Died Same Year
If you have a child who died in the year of birth, and you did not apply for the child’s social security number, an exception applies to including that child’s social security number. However, you are required to attach a copy of the child’s birth certificate to your tax return and print the word “‘died” in column (2) of line 6c of your 1040 Form or 1040A Form.

Non-resident Alien
If you are claiming for a dependent who is a non-resident alien that does not qualify to receive a social security number, you must use the individual’s individual taxpayer identification number (ITIN) instead.

Obtaining Identification Numbers
Social security numbers can be obtained in the US by completing an application at your local Social Security office, or at the U.S. consulate for individuals who live outside the US.

An ITIN may be obtained by filing IRS Form W-7 with the IRS, or by working with IRS-authorized Acceptance Agent, which are available in most states and some foreign countries.

If you are applying for an ITIN at the same time you are filing your tax return, you may need to send the application and the tax return to the following address, instead of sending the tax return to the usual address to which tax-returns are mailed.

If you changed your name due to marriage, divorce or other legal reasons such as a deed poll, you should contact the social security administration (SSA) to have the change reflected, so as to ensure that there is no discrepancy between the IRS and SSA records, as that could result in the processing of your return being delayed.

To read more frequently asked tax questions, How do I file taxes for income from foreign sources?,Does everyone have to file a federal tax return?, How can I make sure I’m ready to file my taxes? and Common Tax Questions Answered.


If you feel you will be unable to file your tax return by the tax deadline, see Get A Six-Month Tax Extension.

Question answered by Denise Appleby, CISP, CRC, CRPS, CRSP, APA