Basic Loopholes in Retirement Plans

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A retirement crisis is looming, and it is making millions of baby boomers – as well as social and economic policymakers – pretty nervous. As boomers approach retirement age, many are worried about adequate income to fund their golden years. And retirement woes are not just a problem in the U.S.; they’re a global concern as well, according to a December 2013 Associated Press piece by David McHugh, Elaine Kurtenbach, and Paul Wiseman.  The worldwide retirement crisis was spawned years before the 2008 recession and the financial meltdown, though it was significantly worsened by those two disastrous events. The AP article cites three contributing factors:

• Countries are drastically cutting retirement benefits and raising the age of eligibility.
• Many companies have eliminated traditional pension plans.
• Individuals who spent freely and failed to save lost much of their wealth in the recession.

Add the fact that retirees are living longer and that the drop in birthrates has resulted in a significantly smaller worker pool to support all of those long-lived folks, and you have the proverbial perfect storm. Millions of people who once dreamed of a carefree retirement are now being forced to consider that they may have to work years past the normal retirement age. Younger people are worried that there will be nothing left when they reach retirement age. In short, the retirement crisis is affecting or will affect just about everyone. The picture looks grim, but it isn’t all bad news. People in the U.S. who are planning for retirement have several options, and may be able to take advantage of the loopholes that exist in some retirement plans.

The Roth IRA
For many high earners, a Roth Individual Retirement Account (IRA) can be a good option for retirement planning. There are two kinds of IRAs, Roth and traditional, with the difference being in tax treatment. With a Roth you deposit after-tax money, and when you’re retired all the income is tax-free. With a traditional IRA, you deposit money that may or may not be deductible on your tax return, and once you’re retired you will have to pay taxes on the amounts in excess of what you didn’t deduct on your taxes now.

“But,” you may be saying, “I can’t contribute to a Roth IRA if I’m a high earner, especially if I’m covered by a 401k plan at work.” That’s where the loophole comes in. Consider contributing to a traditional IRA and converting it to a Roth IRA, which will allow you to maximize your retirement income while minimizing taxes on it. Do be aware that when you convert your traditional IRA to a Roth you will be taxed on the untaxed portion. If you have a traditional IRA balance in excess of your current non-deductible contribution you will be taxed proportionally to your contribution. So in order for the loophole to work best, you should not have any traditional/rollover IRA other than the one you’re converting. For more information click here. 

Health Savings Accounts
Technically speaking, Health Savings Accounts, or HSAs, aren’t retirement plans. They’re best used for the purpose for which they were intended: to help with health care costs, which by current estimates could be $200,000 or more for the average American after retirement. However, according to Paul Fronstin, director of health research at the Employee Benefits Research Institute, HSAs are trusteed like Individual Retirement Accounts under IRS rules. Therefore, even though an HSA’s primary role is to serve as a savings account to offset the cost of high-deductible health plans, you can deposit pre-tax dollars (or deduct your contributions), and the money grows tax-free, similar to an IRA or 401K. You can learn more by reading IRS Publication 969. There are a few caveats, however; for more information click here.

The public pension retire-rehire loophole
There’s a loophole in many public pension systems that allows public employees such as schoolteachers, firefighters, or cops to “retire” for a short period, then return to work at full pay and at some point begin collecting retirement benefits and salary. Granted, this “double dipping” is controversial because it has been misused. Moreover it isn’t legal in all states, and there are questions about its long-term sustainability in places where it is legal. But it might be an option for you to consider.

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This is not financial advice and, of necessity, it is a far from complete review of all of the different retirement plans available and their various loopholes. In addition, laws are always subject to change, which could close some loopholes and open others. You should always talk to a qualified, licensed financial planner or tax adviser before making any decisions that will affect your taxes or any aspect of your finances.

One final point to consider: Not being able to retire at the age of 65 isn’t necessarily a bad thing. If you’re doing work you truly love, you may not want to retire. But those who want to retire do have options, and there are plenty of resources available for information and assistance.

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Author: This is a guest post by Sarah Brooks from Freepeoplesearch.org, a people finder site. She is a Houston-based freelance writer and blogger. Questions and comments can be sent to brooks.sarah23 @ gmail.com.