Now's the Time to Make Your IRA Contribution

Have you made your IRA (individual retirement account) contribution for the 2004 tax-year yet? If not, now's the time as the April 15, 2005, deadline approaches. You can contribute up to $3,000 to a Roth IRA or a traditional IRA, and if you're age 50 or older you also can make an extra $500 catch-up contribution.

Now's also the time to get an early jump on your year 2005 IRA contribution, because you can make that contribution anytime between Jan. 1 of 2005 and April 15 of 2006. Plus, you can contribute more for 2005 because the annual contribution limit increases to $4,000.

Traditional IRAs

With a traditional IRA, earnings accumulate tax deferred, so you won't owe income taxes until you make withdrawals. And if you meet the eligibility requirements, your contributions are tax deductible. Deductible contributions and earnings then are taxed at your regular income tax rate as you withdraw them.

To make tax-deductible contributions to a traditional IRA, you must be younger than age 70� and have income earned from working. From there, you're automatically eligible if neither you, nor your spouse if you're married, is covered by an employer-sponsored retirement plan.

If you're a single taxpayer and you are covered by an employer-sponsored retirement plan, or you're a married taxpayer and either you or your spouse are covered by an employer plan, your eligibility depends on your modified adjusted gross income. (Your modified adjusted gross income is basically your adjusted gross income with some deductions and exclusions added back.) Here are the rules for 2004 and 2005 tax-year contributions:

If you're a single taxpayer, you can deduct up to the annual limit if your income is less than $50,000 ($45,000 for the 2004 tax year). If your income is between $50,000 and $60,000 ($45,000 and $55,000 for the 2004 tax year) you can deduct a partial contribution.

If you're a married taxpayer and file a joint return, and you're covered by an employer plan, you can deduct up to the annual limit if your joint income is less than $70,000 ($65,000 for the 2004 tax year). If your income is between $70,000 and $80,000 ($65,000 and 75,000 for the 2004 tax year) you can deduct a partial contribution.

If you're a married taxpayer and file a joint return, and you're not covered by an employer retirement plan but your spouse is, you can deduct up to the annual limit if your joint income is less than $150,000. If your joint income is between $150,000 and $160,000 you can deduct a partial contribution.

Roth IRAs

Contributions to a Roth IRA aren't tax deductible. But in favorable contrast to a traditional IRA, earnings accumulate tax deferred and are free from income tax upon withdrawal, if you meet the specified conditions.

A Roth IRA also has more flexible early withdrawal rules than a traditional IRA, and you aren't required to begin withdrawals at age 70�.

Your participation in an employer-sponsored retirement plan doesn't affect your Roth IRA eligibility. You can contribute to a Roth IRA at any age if you're still working, and if your modified adjusted gross income is less than the annual limit:

If you're a single taxpayer and your income is less than $95,000, you're eligible to contribute up to the annual limit. You're eligible to make a partial contribution if your income is between $95,000 and $110,000.

If you're married and file a joint tax return, and your joint income is less than $150,000, you're each eligible to contribute up to the annual limit. You're eligible to make a partial contribution if your income is between $150,000 and $160,000.

Sorting out your IRA options

If you're eligible to contribute to a Roth IRA and also to make tax-deductible contributions to a traditional IRA: Assuming you would contribute the same amount to either type of IRA, your decision depends on what you would do with the money you save in taxes if you make tax-deductible contributions to a traditional IRA. Your decision also depends on your projected tax bracket in retirement.

For example, if you contribute $4,000 a year to a traditional IRA and you're in the 25% federal income tax bracket, your tax bill would be reduced by $1,000. Would you take this amount from any tax refund you receive, or from your savings, and invest it in a taxable account for retirement each year?

If you would invest this savings and add it to your traditional IRA, and you project that your income tax bracket in retirement will significantly decrease, you would have more after taxes at retirement with a traditional IRA than a Roth IRA. The reason: You're sheltering your current income from a higher tax rate now and making withdrawals later at a lower tax rate.

On the other hand, even if you would invest this savings, but you project that your income tax bracket in retirement will stay about the same, fall only slightly, or increase, you'll have more after taxes with a Roth IRA than a traditional IRA.

Similarly, if you would not invest this savings, you'll have more after taxes at retirement with a Roth IRA. That's because you spent all your upfront tax savings from your traditional IRA contributions, so that money is not part of your retirement fund.

If you're not eligible to make tax-deductible contributions to a traditional IRA but you're eligible to contribute to a Roth IRA: You'll have more after taxes at retirement if you contribute to a tax-free Roth IRA rather than making non-deductible contributions to a tax-deferred traditional IRA.

If you're only eligible to make nondeductible contributions to a traditional IRA: Whether this type of IRA contribution is right for you depends on what types of investments you'll make and your other available retirement savings options.

Bobbie Shocket Lazarz, Certified Financial Planner Professional ^TM, MSW, MBA, is the primary author of the CUNA Mutual Group's Education Center Web site. Lazarz has been educating credit union members about personal finance for 15 years. The CUNA Mutual Group is the leading provider of financial services to credit unions and their members nationwide.

December 6, 2004