Design an IRA Strategy That's Right for You
by Dick Radtke
Retirement security has received tremendous media attention recently, as the administration pursues its Social Security privatization plan, and both supporters and detractors make their case. Whatever the outcome of that proposal, it is a given that Americans need to do a better job in preparing for their senior years. Equity and bond investments, 401(k) savings plans, credit union savings accounts, and even part-time employment all may play a part in assuring a financially sound future. And for millions of people, an IRA (individual retirement account) is part of the formula for success.
What are IRAs, and how can they play a role in your retirement planning? What kinds of IRA programs are available, and what are the basic rules governing their use? Let's take a look at each of these issues.
Perhaps the most important advantage of IRAs as a savings instrument is that they offer important tax advantages--either now or later.
The two basic types of IRAs are traditional and Roth. Traditional IRAs are divided into tax-deductible and nondeductible types. Contributions to Roth IRAs are not tax-deductible, but their earnings can be distributed tax-free if certain conditions are met. All of this makes a difference when owners or beneficiaries begin withdrawing funds. For a primer on the basic provisions of IRAs, go to IRS (Internal Revenue Service) publication 590.
How much can I contribute?
For 2005 through 2007, the contribution limit for both Roth and traditional IRAs is the smaller of either $4,000 or your taxable compensation for the year. If you are age 50 or older, that limit rises to the smaller of your taxable compensation for the year or $4,500 (2005) or $5,000 (2006 and 2007). The amount a member can contribute to Roth IRAs is phased out based on the member's taxable income. A member who attains age 70 1/2 by the end of a year cannot make regular contributions to traditional IRAs for that year.IRAs offer important tax advantages.
What kind of IRA is best for me?
The advantage of a traditional IRA is that it may provide a tax deduction for the year. If you are in the 25% tax bracket and contribute $4,000 to a traditional IRA, you reap an immediate $1,000 in tax savings. But the IRS considers the entire $4,000 plus all earnings taxable when you withdraw the money. The tax deduction of a member who participates in a retirement plan or whose spouse participates in a retiremenmt plan is phased out based on the member's taxable income.
A Roth IRA, by contrast, offers no immediate tax advantage, but all earnings can be tax-free at withdrawal. If the requirements for tax-free distributions are met, all proceeds come to you with no tax liability. Therefore, if you expect to reap substantial earnings on your IRA investment over time, the Roth option might be preferable. If you need the tax advantage immediately, a traditional IRA might be best. But remember: The basic purpose of an IRA is to provide financial security in the future.
Can my spouse participate?
Yes. If your husband or wife does not have a paying job, you can make a contribution in his or her name each year.The purpose of an IRA is to provide financial security in the future.
Can I create more than one IRA?
There's no limit to the number of IRAs you can own, but consider carefully why you may need multiple accounts and what the consequences are. While diversification is an admirable goal, a single IRA brokerage account can achieve diversification without the blizzard of periodic statements (and tax forms) that multiple accounts produce. With a single account, you also can avoid paying multiple annual service fees.
The argument in favor of multiple IRAs is that if you plan to leave the proceeds to several beneficiaries, you can name separate beneficiaries for each account. This avoids disputes over how the proceeds are allocated after your death.
When can I withdraw funds from an IRA?
You can withdraw money from a traditional IRA without penalty beginning at age 59 �. Funds withdrawn earlier are likely to be charged a 10% penalty, although the penalty may be waived under some circumstances. And you must begin withdrawing funds by age 70 �.
You can withdraw regular contributions to a Roth IRA tax-free at any time. You can withdraw your entire Roth IRA balance tax-free after age 59 1/2 if you have had a Roth IRA at least five years at the time of withdrawal.
Can I structure an IRA to benefit my children or grandchildren?
Under what is known as a Stretch Roth IRA, you may extend the period of tax-deferment over generations. By extending the payout over the life expectancy of your children or grandchildren the IRA gets additional deferral years to compound earnings growth. But Stretch IRAs depend upon a number of important assumptions, and any change in these assumptions can change the potential value of the account. Check with your financial adviser or your credit union IRA specialist to determine whether a Stretch IRA is right for you.
IRAs offer a host of options to fit specific lifestyles and circumstances.
In his book "Parlay Your IRA into a Family Fortune," retirement expert Ed Slott offers a three-step strategy that cuts through the tax laws and provides simple, easy-to-follow instructions for managing IRA income. The book details what you must do to ensure that your beneficiaries will have all options available to capitalize on the opportunity you've created for them to keep the account growing.
The bottom line
In the three decades since it was first introduced, the IRA has become a popular and flexible tool to help Americans prepare for their future financial security. It offers a host of options designed to meet the needs of a variety of lifestyles and circumstances, and can make the difference between just getting by and living the retirement life of your dreams. But because the rules regarding IRAs can be tricky, it's a good idea to check with a financial pro as you develop your plan.
May 16, 2005
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