About this time, you’re probably sick of hearing about IRA accounts, whether from brokers urging
you to invest money, to your tax preparer searching for deductions. IRA’s are a great idea, but
which one should you choose – traditional, nondeductible, or Roth? This article gives some
pointers on choosing your best option.
First, before considering any IRA, make sure you are maximizing your contribution to your 401(k)
account at work. Make sure you are getting the full employer match that may be available to you.
You’ll also benefit from the professional management of your account that often accompanies
employer-sponsored plans. And, even if you change jobs frequently so that the employer match
doesn’t vest for you, you will always get to keep your own contributions plus all the appreciation
on what you’ve put in.
Traditional IRA
This type provides an immediate tax deduction for the amount you contribute. If you contribute
the maximum $4,000 allowed ($5,000 for those ages 50 and above) and you are in the 25% tax
bracket, your immediate tax savings is $1,000. Your investment grows tax-deferred, which means
you pay no tax on any appreciation until you start withdrawals, at which time all moneys you take
out are taxed.
Your ability to make a deductible IRA contribution depends upon your income and whether your
spouse is covered by a retirement plan at work. If you are single, or married and neither spouse
is covered by a retirement plan (i.e., the “retirement plan” box on form W-2 is not checked), each
person can contribute up to $4,000. If you are covered by a retirement plan at work, your ability
to contribute to a traditional IRA phases out between $75,000 and $85,000 of adjusted gross
income (married filing jointly) or between $50,000 and $60,000 as a single or head of household
filer. If your spouse is covered by a retirement plan at work and you are not, your ability to
contribute phases out between $150,000 and $160,000 of adjusted gross income. To contribute
the maximum $4,000 ($5,000 for those 50 or older), your earned income (income from
employment) must be at least that amount; otherwise, your contribution cannot exceed your
earned income.
Nondeductible IRA
This type does not give you the benefit of an immediate tax deduction, but the contributions grow
tax-deferred until withdrawal. When you begin to take your distributions, a portion is taxed as
appreciation, and a portion is not taxed, representing a return of your nondeductible investment.
There is no income limitation on your ability to contribute to a nondeductible IRA, nor is there any
prohibition on participating in an employer retirement plan. The major advantage to using this
type of plan is that the earnings grow tax-deferred, which may mean more money for you at the
end, rather than simply saving through a taxable account.
Roth IRA
A Roth IRA is like a nondeductible IRA in that there is no immediate tax deduction for your
contribution. However, none of the appreciation is ever taxed – making it a superior choice over
nondeductible IRA’s. Roth accounts also have the advantage of not being subject to mandatory
distributions beginning at age 70 ½. The big drawback to the Roth is that adjusted gross income
cannot exceed $110,000 for a single or head of household filer or $160,000 for married filing
jointly couple.
So, which to choose?
The question of Roth versus nondeductible IRA is easy – choose the Roth and never have to pay
tax on the appreciation. If you cannot contribute to a Roth because of income limitations, a
nondeductible IRA is better than just stashing the money in a regular taxable account, assuming
your income tax bracket at retirement is the same or lower than your current tax bracket.
Now – here’s the difficult question. Which is better – a traditional IRA, which
gives you an immediate tax benefit but taxes the distributions, or a Roth, with no immediate tax
benefit but no tax on the appreciation? The answer depends on three factors: your age until
distributions must start, your current income tax bracket, and your expected tax bracket at
retirement. In general, the longer the period you have to make contributions, the Roth tends to be
the better choice. However, each individual needs to talk to their tax advisor or a retirement
planner to decide which option is best. There are also retirement planning calculators available
on many web sites to help you in your analysis.
A final word. No matter what your choice, the most important factor is to start saving early. An
individual who makes a $2,000 contribution each year beginning at age 22, but then stops at age
31, will accumulate $580,000 by age 65, assuming a 9% annual return. Compare this to someone
who waits until age 31 to start contributions, but then tries to make up for lost time by contributing
$2,000 per year until age 65. Their balance at retirement will only be $470,000, assuming the
same 9% compounding rate. Some savvy parents try to encourage their children to start their IRA
savings early by opening an account for them at graduation – the idea being that it’s easier for
them to save if the plan is already set up for them. For wealthy parents, an annual gift to a child’s
IRA is also a great way to avoid estate tax while helping their children save for the future.
April 15, 2008 is the contribution deadline for making a contribution for the 2007 tax year.
Choose the IRA type that’s best for you, but more importantly, choose to make a contribution.
you to invest money, to your tax preparer searching for deductions. IRA’s are a great idea, but
which one should you choose – traditional, nondeductible, or Roth? This article gives some
pointers on choosing your best option.
First, before considering any IRA, make sure you are maximizing your contribution to your 401(k)
account at work. Make sure you are getting the full employer match that may be available to you.
You’ll also benefit from the professional management of your account that often accompanies
employer-sponsored plans. And, even if you change jobs frequently so that the employer match
doesn’t vest for you, you will always get to keep your own contributions plus all the appreciation
on what you’ve put in.
Traditional IRA
This type provides an immediate tax deduction for the amount you contribute. If you contribute
the maximum $4,000 allowed ($5,000 for those ages 50 and above) and you are in the 25% tax
bracket, your immediate tax savings is $1,000. Your investment grows tax-deferred, which means
you pay no tax on any appreciation until you start withdrawals, at which time all moneys you take
out are taxed.
Your ability to make a deductible IRA contribution depends upon your income and whether your
spouse is covered by a retirement plan at work. If you are single, or married and neither spouse
is covered by a retirement plan (i.e., the “retirement plan” box on form W-2 is not checked), each
person can contribute up to $4,000. If you are covered by a retirement plan at work, your ability
to contribute to a traditional IRA phases out between $75,000 and $85,000 of adjusted gross
income (married filing jointly) or between $50,000 and $60,000 as a single or head of household
filer. If your spouse is covered by a retirement plan at work and you are not, your ability to
contribute phases out between $150,000 and $160,000 of adjusted gross income. To contribute
the maximum $4,000 ($5,000 for those 50 or older), your earned income (income from
employment) must be at least that amount; otherwise, your contribution cannot exceed your
earned income.
Nondeductible IRA
This type does not give you the benefit of an immediate tax deduction, but the contributions grow
tax-deferred until withdrawal. When you begin to take your distributions, a portion is taxed as
appreciation, and a portion is not taxed, representing a return of your nondeductible investment.
There is no income limitation on your ability to contribute to a nondeductible IRA, nor is there any
prohibition on participating in an employer retirement plan. The major advantage to using this
type of plan is that the earnings grow tax-deferred, which may mean more money for you at the
end, rather than simply saving through a taxable account.
Roth IRA
A Roth IRA is like a nondeductible IRA in that there is no immediate tax deduction for your
contribution. However, none of the appreciation is ever taxed – making it a superior choice over
nondeductible IRA’s. Roth accounts also have the advantage of not being subject to mandatory
distributions beginning at age 70 ½. The big drawback to the Roth is that adjusted gross income
cannot exceed $110,000 for a single or head of household filer or $160,000 for married filing
jointly couple.
So, which to choose?
The question of Roth versus nondeductible IRA is easy – choose the Roth and never have to pay
tax on the appreciation. If you cannot contribute to a Roth because of income limitations, a
nondeductible IRA is better than just stashing the money in a regular taxable account, assuming
your income tax bracket at retirement is the same or lower than your current tax bracket.
Now – here’s the difficult question. Which is better – a traditional IRA, which
gives you an immediate tax benefit but taxes the distributions, or a Roth, with no immediate tax
benefit but no tax on the appreciation? The answer depends on three factors: your age until
distributions must start, your current income tax bracket, and your expected tax bracket at
retirement. In general, the longer the period you have to make contributions, the Roth tends to be
the better choice. However, each individual needs to talk to their tax advisor or a retirement
planner to decide which option is best. There are also retirement planning calculators available
on many web sites to help you in your analysis.
A final word. No matter what your choice, the most important factor is to start saving early. An
individual who makes a $2,000 contribution each year beginning at age 22, but then stops at age
31, will accumulate $580,000 by age 65, assuming a 9% annual return. Compare this to someone
who waits until age 31 to start contributions, but then tries to make up for lost time by contributing
$2,000 per year until age 65. Their balance at retirement will only be $470,000, assuming the
same 9% compounding rate. Some savvy parents try to encourage their children to start their IRA
savings early by opening an account for them at graduation – the idea being that it’s easier for
them to save if the plan is already set up for them. For wealthy parents, an annual gift to a child’s
IRA is also a great way to avoid estate tax while helping their children save for the future.
April 15, 2008 is the contribution deadline for making a contribution for the 2007 tax year.
Choose the IRA type that’s best for you, but more importantly, choose to make a contribution.
Disclaimer of Liability
The information in this e-newsletter is for general guidance only, and does not constitute the provision of legal advice, tax advice,
accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used
as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or
taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular
situation.
The author of the tax articles in this e-newsletter did not intend nor write the advice to be used to avoid any penalty imposed by a
taxing authority, nor may any user/recipient of this document use this document's written tax advice for that purpose. This document's
tax advice was written specifically to support the promotion or marketing of the transaction/matter addressed by the written tax advice.
Therefore, any user/recipient of this document should seek an independent tax professional's advice regarding the user/recipient's
particular circumstances.
The information is provided "as is" with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and
without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for
a particular purpose.
The information in this e-newsletter is for general guidance only, and does not constitute the provision of legal advice, tax advice,
accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used
as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or
taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular
situation.
The author of the tax articles in this e-newsletter did not intend nor write the advice to be used to avoid any penalty imposed by a
taxing authority, nor may any user/recipient of this document use this document's written tax advice for that purpose. This document's
tax advice was written specifically to support the promotion or marketing of the transaction/matter addressed by the written tax advice.
Therefore, any user/recipient of this document should seek an independent tax professional's advice regarding the user/recipient's
particular circumstances.
The information is provided "as is" with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and
without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for
a particular purpose.
| Serving the Central Pennsylvania area since 1981 |
| Robert A. Romako, CPA |
| IS THERE AN IRA IN YOUR FUTURE? |
MARCH 2008
| Robert A. Romako, CPA Phone:717.774.3047 |