S.T.E.P.S. – Smart, Tailored, Event-Driven, Packaged Solutions
Individual Retirement Accounts (IRA’s) — Part IV
If the benefits you’ll receive from the government and your employer aren’t going to be enough to support your lifestyle after you stop working, don’t be alarmed. You have options – proactive investment strategies – that can help you get your retirement fund up and running.
- Individual Retirement Account (IRA)
- Roth Individual Retirement Account (certain income brackets only)
- ESA: Education IRA
A. Traditional Individual Retirement Account (IRA)
A traditional IRA is a popular and attractive proactive retirement investment strategy. Whether you work for yourself, already have a retirement plan offered by your employer, or you don’t work at all, you can open up a traditional IRA in which you can start to save for your retirement today.
HerTip: The Internal Revenue Service has proposed new simplified minimum distribution regulations for mandatory distributions from IRA’s, 401(k), 403(b), profit sharing, Keogh and all other qualified plans. Click here for details.
How it Works:
Most people with earned income can open up a traditional IRA.
Under current law (2006), you can contribute up to $4,000 per year to your IRA. If you’re married and either you or your spouse does not work, the working partner can contribute up to $4,000 per year into a spousal IRA. Because you are opening an IRA without the support of an employer, you are free to invest your IRA in a multitude of approved investments.
According to the new Bush tax plan, by the year 2008, limits for contributions to Individual Retirement accounts will rise from $4,000 to $5,000.
In all cases, the earnings in your IRA are tax deferred. In other words, you won’t pay taxes on income on your retirement funds until you retire or receive any disbursement. (Therefore “deferring” the taxes you owe.) This is a key advantage and can translate to big savings in the long run. By not paying certain taxes on your earnings per year, your investment compounds untaxed. This means that your earnings continuously add to your investment total, allowing you to earn interest on a larger amount each year.
HerTip: If you open an IRA before the April 15 tax deadline, you might be eligible to deduct your contribution from the previous year’s tax return. Any losses incurred on your IRA are not deductible.
Depending on your level of earned income and also whether you or your spouse are a participant in a qualified retirement plan, the contribution you make to your IRA may also be tax deductible. Deductions help lower your taxes by your marginal tax rate. So, the higher your tax bracket, the higher your tax savings.
For example, if you have contributed $100 to your pension and you have a 32% tax rate, then you can save $32 on your taxes. If your tax rate is 25%, then you can save $25 from your taxes and so on.
Pay-out:
You can contribute to your IRA until you reach 70 1/2 years of age. You then must start withdrawing capital at the rate given by an IRS schedule.
HerTip: You may take your money out of an IRA prior to 591/2 under certain conditions. In these cases you still must pay a tax when you take the money out, but you are not subject to the penalty.
B. Roth IRA
In any particular year, if your household income is less than $160,000 (married) or $110,000 (unmarried), you may want to consider another type of individual retirement account – a Roth IRA. Although the funds inside of a traditional IRA grow tax deferred, they grow tax free in a Roth IRA.
How It Works:
Like a traditional IRA, you and your husband can each put up to $2,000 per year into a Roth IRA, even after you reach age 70 ½, but your tax contribution is not deductible from your income in the year that you make the contribution. Also like a traditional IRA, you are responsible for choosing your investment vehicles.
Pay- out:
You can withdraw all the principle and earnings of a Roth IRA totally tax free as long as your Roth IRA has existed over 5 years, and:
- You are over the age of 59 ½ or
- Your Roth IRA is being used to buy your first home or
- Your Roth IRA is being used to cover a medical disability
HerTip: Unlike a traditional IRA, you do not have to take distributions from a Roth IRA when you reach 70 1/2. In fact, you don’t have to take your distributions at all. In this case, you may pass your assets to your beneficiaries.
Coverdell ESA: Educational Savings Account (formally known as Education IRA)
If are married and filing jointly your household combined income is less than $190,000 and you have a child under the age of 18, you may qualify for an ESA. Single head of household income must be less than $95,000
How it works:
Parents, grandparents and children can contribute up to $2000 (in total) per year per child. These funds will grow tax-deferred until they are withdrawn tax-free for qualified higher education costs.
Pay-out:
The money saved in an ESA must be distributed before the beneficiary reaches her/his 30th birthday. An ESA contribution can be made regardless of whether contributions have been made to other IRAs.
HerTip: ESA’s put money in the student’s name. When applying for scholarships, this money can count against them.
Where do I go to open an IRA?
You cannot open an IRA on your own, but opening an IRA is as simple as going to your local bank or brokerage firm. WFNInvest offers our own retirement accounts through Siebert Financial Corp. Go there now to learn more.
But, all IRAs are not created equal. Different institutions will have varied IRA options and costs. Before opening an IRA, consider the following:
- Cost to open the IRA
- Income earned with the IRA
- Investment flexibility
- Annual fees
Part V: Retirement saving for the self-employed
In this course, we will cover the following: