Monday, December 8, 2014
EVERYBODY OUGHT TO HAVE AN IRA
In his classic Broadway musical A FUNNY THING etc Steve Sondheim tells us that “Everybody Ought to Have a Maid”. I certainly don’t disagree.
I also feel that everybody ought to have an IRA.
Everybody with earned income, and regardless of age, level of income or wealth, or coverage under an employer plan, should have an IRA as a form of secured savings. This is because of the multiple benefits of an IRA account – the tax deferred, or tax free, accumulation of income, the possible tax deduction it can provide, and the fact that they are, in most cases, protected from general creditors to whom you may owe outstanding debts and during bankruptcy procedures.
You should, of course, first take as much advantage as possible within your budget of your employer’s 401(k), 403(b), 457, or whatever retirement plan, hopefully eventually to the maximum annual allowable contribution.
Some employers offer a ROTH option for contributions. Employee contributions to a traditional 401(k), etc are “pre-tax” and reduce the amount of taxable federal and often state wages reported on Form W-2. If you are in the 25% federal bracket this provides an immediate 25% “return on investment”. With a ROTH 401(k) employee contributions are “after tax”, but distributions at retirement are totally tax free. As with traditional 401(k) plans, ROTH 401(k)s require annual minimum distributions at age 70½, but you can avoid this by rolling your ROTH 401(k) into a ROTH IRA when you retire.
Younger employees just starting out should opt for the ROTH 401(k) if it is available. Older employees, who are used to the “pre-tax” treatment of employee contributions, may want to consider contributing any annual inflation-based increases to the maximum amount allowed to a ROTH account.
But you should not stop there. Once you have maxed out contributions to your employer plan you should contribute to an IRA – again hopefully eventually to the maximum allowable contribution.
Before I discuss IRAs further I refer you to POSITIVELY TAXES - JUST ABOUT EVERYTHING YOU ALWAYS WANTED TO KNOW ABOUT AN IRA from my DOLLAR STORE.
For both 2014 and 2015 the maximum amount you can contribute to an IRA, either traditional or ROTH, is $5,500. The additional “catch-up contribution” if age 50 or older is $1,000, also for both years.
Here is the other information you need to know for 2014 and 2015:
The deduction for contributions to a traditional IRA by taxpayers who are active participants in an employer retirement plan is phased out for Single and Head of Household filers with AGI between $60,000 and $70,000 and for those who are Married Filing Joint and Qualifying Widow(er) with AGI of $96,000 to $116,000.
The deduction on a joint return for a spouse that is not an active participant in an employer plan but who is married to one who is phases out at AGI of $181,000 to $191.000.
The AGI phase-out range for taxpayers making contributions to a Roth IRA is $114,000 to $129,000 for Single and Head of Household filers and $181,000 to $191,000 for Married Filing Joint and Qualifying Widow(er).
The deduction for contributions to a traditional IRA by taxpayers who are active participants in an employer retirement plan is phased out for Single and Head of Household filers with Adjusted Gross Income (AGI) between $61,000 and $71,000 and for those who are Married Filing Joint and Qualifying Widow(er) with AGI of $98,000 to $118,000. The phase-out range for a married taxpayer filing a separate return who is covered by an employer plan is $0 - $10,000.
The deduction on a joint return for a spouse that is not an active participant in an employer plan but who is married to one who is phases out at AGI of $183,000 to $193.000.
The AGI phase-out range for taxpayers making contributions to a Roth IRA is $116,000 to $131,000 for Single and Head of Household filers and $183,000 to $193,000 for Married Filing Joint and Qualifying Widow(er). The phase-out range for a married taxpayer filing a separate return who is covered by an employer plan is $0 - $10,000.
Ideally you should contribute to a ROTH IRA – so your contributions will grow tax-free (and not just tax deferred) and will not be subject to RMD rules at age 70½. FYI - accumulations in a ROTH IRA can be passed on totally tax-free to beneficiaries when you go to your final audit.
However, depending on your financial situation, the tax-deductibility of all or part of traditional IRA contributions may be more beneficial.
My post “ADVICE FOR A NEW GRADUATE STARTING OUT IN HIS/HER FIRST FULL-TIME JOB” from this summer provides two suggestions for funding IRA contributions if you are just starting out –
ü If you have any cash from graduation gifts left over open a ROTH IRA account and use this money to fund your 2014 contribution.
ü Take an empty coffee can, or other form of “piggy bank”, and put it in your bedroom. Beginning with the first week of January 2015, put $10, $20, or $50 in this “bank” each week. On January 2nd of 2016 take the money that has accumulated in this “bank” and contribute it to your ROTH IRA for tax year 2016. Continue this practice for 2016 and subsequent years.
If you cannot contribute to either a ROTH or a deductible IRA, based on income and other limitations, you should still contribute to a non-deductible IRA. Doing so will create a “basis” in your IRA investments and part of eventual withdrawals will be partially tax free as a “return of basis”.
If your income is too high to be able to contribute directly to a ROTH IRA you can use a special tax trick to make a “back door” contribution. Make the contribution to a non-deductible traditional IRA account and then turn around and convert the account to a ROTH IRA. This is also discussed in the POSITIVELY TAXES report referenced above.
While you should certainly consider contributing to Section 529 plans and Coverdell Education Savings Accounts, you can also use IRAs to save for education, as well as excessive medical expenses and buying a home, as exclusions to the premature withdrawal penalty exist for these types of expenses, and withdrawals from a ROTH IRA are always tax and penalty free to the extent of your contributions.