Eric Tyson - Mutual Funds For Dummies

For-profit companies typically offer 401(k) plans, which typically allow you to save up to $20,500 per year (tax year 2022), $27,000 for those 50 and older. Your contributions to a 401(k) are excluded from your reported income and are free from federal and state income taxes but not from FICA (Social Security) taxes.

Absolutely don’t miss out on contributing to your employer’s 401(k) plan if your employer matches a portion of your contributions. Your company, for example, may match half of your first 6 percent of contributions (so you save a lot of taxes and get a bonus from the company). Check with your company’s benefits department for your plan’s details.

Smaller companies (those with fewer than 100 employees) can consider offering 401(k) plans, too. In the past, administering a 401(k) was prohibitively expensive for smaller companies. If your company is interested in this option, contact a mutual fund organization, such as T. Rowe Price, Vanguard, or Fidelity, or a discount brokerage house, such as Charles Schwab or Sharebuilder.

Many nonprofit organizations offer 403(b) plans to their employees. As with a 401(k), your contributions are federal- and state-tax-deductible. The 403(b) plans often are referred to as tax-sheltered annuities, the name for insurance-company investments that satisfy the requirements for 403(b) plans. No-load (commission-free) mutual funds can be used in 403(b) plans. Check which mutual fund companies your employer offers you to invest through — I hope you have access to the better ones covered in Chapter 9.

Employees of nonprofit organizations generally are allowed to contribute up to 20 percent or $20,500 of their salaries ($27,000 for those individuals 50 and older) — whichever is less. Employees who have 15 or more years of service may be allowed to contribute more. Ask your employee benefits department or the investment provider for the 403(b) plan (or your tax advisor) about eligibility requirements and details about your personal contribution limits.

If you work for a nonprofit or public-sector organization that doesn’t offer this benefit, make a fuss and insist on it. Nonprofit organizations have no excuse not to offer a 403(b) plan to their employees. This type of plan includes virtually no out-of-pocket setup expenses or ongoing accounting fees like a 401(k) (see the preceding section). The only requirement is that the organization must deduct the appropriate contribution from employees’ paychecks and send the money to the investment company that handles the 403(b) plan. (Some state and local governments offer plans that are quite similar to 403(b) plans and are known as Section 457 plans.)

If you’re self-employed or a small-business owner, you can establish your own retirement savings plans. Simplified employee pension individual retirement account (SEP-IRA) plans require little paperwork to set up. They allow you to sock away 20 percent of your self-employment income (business revenue minus expenses) up to a maximum of $61,000 per year. Each year, you decide the amount you want to contribute — you have no minimums. Your contributions to a SEP-IRA are deducted from your taxable income, saving you big-time on federal and state taxes. As with other retirement plans, your money compounds without taxation until withdrawal.

Anyone with employment (or alimony) income can contribute to Individual Retirement Accounts (IRAs). You may contribute up to $6,000 each year ($7,000 if you’re age 50 and older) or the amount of your employment or alimony income if it’s less than these amounts in a year. If you’re a nonworking spouse, you may be eligible to contribute into a spousal IRA.

Your contributions to an IRA may be tax-deductible. For the tax year 2022, check out these eligibilities:

If you’re single and your adjusted gross income (AGI) is $78,000 or less for the year, you can deduct your IRA contribution.

If you’re married and file your taxes jointly, you’re entitled to a full IRA deduction if your AGI is $129,000 per year or less.

If you make more than these amounts, you can still take a full IRA deduction if you aren’t an active participant in any retirement plan. To know for certain whether you’re an active participant, look at the W-2 form that your employer sends you early in the year to file with your tax returns. Little boxes indicate whether you’re an active participant in a pension or deferred-compensation plan. If either box is checked, you’re an active participant.

If you’re single taxpayer with an AGI above $68,000 but below $78,000, or part of a couple with an AGI above $109,000 but below $129,000, you’re eligible for a partial IRA deduction, even if you’re an active participant. The size of the IRA deduction you may claim depends on where you fall in the income range. For example, a single-income earner at $73,000 is entitled to half of the full IRA deduction (assuming they are under age 50) because their income falls halfway between $68,000 and $78,000. ( Note: These thresholds are for tax year 2022. They’ll increase in the tax years ahead.)

If you yourself are not an active participant in a retirement plan but your spouse is an active participant, then you may take a full IRA deduction if your AGI is $204,000 or less. A partial deduction is allowed in this case if your AGI is between $204,000 to $214,000.

If you can’t deduct your contribution to a standard IRA account, consider making a nondeductible contribution to a type of IRA account called the Roth IRA. Single taxpayers with an AGI of $129,000 or less and joint filers with an AGI of $204,000 or less can contribute up to $6,000 per year to a Roth IRA ($7,000 for those individuals age 50 and older). Although the contribution isn’t deductible, earnings inside the account are shielded from taxes, and unlike a standard IRA, qualified withdrawals from the account, including investment earnings, are free from income tax.

To make a qualified withdrawal from a Roth IRA, you must be at least 59½ and have held the account for at least five years. An exception to the age rule is made for first-time homebuyers, who are allowed to withdraw up to $10,000 toward the down payment on a principal residence.

A place to call your own is certainly the most tangible element of the American dream. Not only does a home generally appreciate in value over the long term, but it also should keep you dry in a thunderstorm (assuming, of course, that you have a good roof!).

To get the best mortgage terms for a house, you should aim for making a down payment of 20 percent of the purchase price. (For a $250,000 home, that’s $50,000.) So unless you have some other sources available (such as a loan from your parents), you have some saving up to do.

If you’re looking to buy a home soon, then a money market fund is the best place to store your down payment money (see Chapter 11). If your target purchase date is in a few years, then consider a short-term bond fund (see Chapter 12). In the rare case that you start saving a decade or more in advance, you can choose a balanced mix of stocks and bonds.