Well, it?s that time again – April 15th is fast approaching – have you funded your IRA yet? Every year the IRS gives us three and a half extra months to make contributions for the previous year and potentially save money on our taxes. Yet every year the dreaded panic starts and the worry begins. Some people like to put off filing their taxes until the last minute just to avoid the pain of handing hard-earned dollars to their favorite Uncle. There are also people holding out simply because they are trying to figure out whether they should be considering a Traditional IRA or a Roth IRA. If you are in this latter group, here are some things to consider:
The Traditional IRA
The actual IRS definition of a traditional IRA is as follows ? A traditional IRA is a personal savings plan that gives you tax advantages for saving for retirement. Contributions to a traditional IRA may be tax deductible ? either in whole or in part. Also, the earnings on the amounts in your IRA are not taxed until they are distributed. The portion of the contributions that was tax deductible also does not get taxed until distributed. A traditional IRA can be established at many different financial institutions, including banks, insurance companies and brokerage firms.
While I do not want to scare you by detailing all of the deductibility rules, this definition may need a little help. So, let?s break this down. A traditional IRA is a personal savings plan that gives you tax advantages for saving for retirement. Therefore a Traditional IRA is any IRA that is not a Roth, SEP, SIMPLE, or Qualified Plan, or a Coverdell ESA.
In addition to potentially benefiting from a tax reduction in the year that you make your contribution, your investments also grow free of federal income taxes until money is withdrawn. Prior to age 70 ? you may set up and fund an IRA if you or your spouse (assuming you file a joint return) has received taxable compensation during the year. This holds true whether or not you are covered by an additional retirement plan – with one caveat: you may not be able to deduct all of your contributions if you or your spouse are covered by an employer?s retirement plan.
Another reason that IRAs are popular is the fact that they may be used as a ?channel? for distributions from a qualified plan such as a 401(k). This is more commonly referred to as a Rollover IRA.
Traditional IRA contribution limits for 2005 and 2006 are $4,000. If you happen to be age fifty or over by the end of the taxable year you may be eligible to make ?catch-up? contributions. These catch-up contributions allow you to make an extra $500 contribution to your IRA in 2005. This amount increases to $1000 in 2006.
A traditional IRA can be established at many different financial institutions, including banks, insurance companies and brokerage firms. There is no limit to the number of IRAs that you can have (however you may want to consider consolidating if your bank, insurance or brokerage firm is charging you fees which take away from your overall return). You may also invest in a variety of different investments inside of your IRA. Many people are led to believe that you may only have CDs inside your IRA. In fact you may own many different types of investments, including stocks, bonds and even real estate (although that is another very tricky topic for another day). Just be careful with what you put inside of your IRA as you want to get the most out of your tax deferral. Many an investor has been led to put an annuity inside of their IRA, which is unnecessary as it is the equivalent of putting a tax deferred investment inside of a tax deferred account.
The Roth IRA
According to the IRS a Roth IRA is also a personal savings plan that operates somewhat in reverse compared to a traditional IRA. For instance, contributions to a Roth IRA are not tax deductible while contributions to a traditional IRA may be deductible. However, while distributions (including earnings) from a traditional IRA may be included in income, the distributions (including earnings) from a Roth IRA are not included in income. For both IRA types ? traditional and Roth ? earnings that remain in the account are not taxed. A Roth IRA can be established at the same types of financial institutions as a traditional IRA.
Simply put, anyone with earned income, subject to limitations, may contribute to a Roth IRA. The participation requirements are similar to those of a traditional IRA except for the fact that a participant may continue to contribute to a Roth IRA after attaining the age of 70 ? so long as he or she has earned income. An individual may contribute to both a traditional and a Roth IRA for a given year, but the total amount of contributions to both accounts may not exceed $4,000 for a tax years 2005 and 2006. Once contributions are made, the earnings grow tax free and the qualified distributions – also known as withdrawals – are tax and penalty free. The contributions may also be recovered without paying taxes and penalties.
People often overlook Roth IRAs as a retirement vehicle because they do not offer the benefit of tax reduction in the tax year that a contribution is made. However, they do offer other benefits. While traditional IRAs require that distributions be taxed, Roth IRAs do not. This is particularly important because it is likely you will have no idea what tax bracket you?ll be in when your distributions will be made. You may be in the 27% tax bracket today, but you may be in the 36% or higher bracket when you retire. Do the math on that. If your retirement account grows to $1,000,000 for example, you may be paying a significantly larger amount in taxes at distribution time than you may have ever anticipated.
Although Roth IRA contribution limits are identical to those for the traditional IRA, they differ from traditional IRAs in the ability of a participant to contribute. The Roth participant may be limited by his adjusted gross income. The maximum amount of regular contributions that can be contributed to a Roth IRA is the lesser of 100% of a participant?s compensation or $4,000 (plus potential catch-up contributions). The $4,000 maximum contribution limit is phased out depending upon the participant?s modified gross income and filing status.
More detailed information may be found on all of these subjects at http://www.placetrade.com/iras.htm or at www.irs.gov.
The information in this article is for discussion and information purposes only. Nothing contained herein should be considered as an offer to buy or sell any security or securities product. Place Trade Financial, Inc. does not provide legal or tax advice. Please consult your own tax and/or legal advisor prior to investing. This article contains links to other web sites. Place Trade Financial is not responsible for the privacy practices or the content of such web sites. Place Trade Financial is a registered broker dealer, but is not registered in all states. Please contact Place Trade Financial at 1-800-50-PLACE for further information. Member NASD, SIPC.
About Place Trade Financial, Inc.
Place Trade Financial, Inc. (Member NASD, SIPC) is a full service, discount brokerage firm based in Lillington, North Carolina, with a branch office in Raleigh, NC as well. Place Trade appeals to clients with various investment needs, by offering a range of products and services ? including stocks, options, mutual funds, extensive fixed income securities, online trading, and no-fee IRAs. Additional services include Wealth Management, college and retirement planning, 401(k) rollovers and business retirement plans. Place Trade Financial, Inc. is also an active member of the Securities Industry Association (SIA). Web address: www.placetrade.com
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About Sarah M. Place:
Sarah M. Place, MBA, President
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