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IRAs – A to Z
By Nancy Zambell, Contributing Editor, Financially Fit
In the October 17, 2006, and October 24, 2006, issues of Financially Fit, I discussed the importance of retirement planning and gave you a brief overview of 401(k) and individual retirement plans (IRAs). With the April 17 tax deadline looming, I thought it an opportune time to bring up IRAs once again.
After all, there are few things in life that our government gives us, and I would wholeheartedly recommend that you take advantage of this important freebie! And Uncle Sam has presented you with an extra gift this year: You have until April 17 (two extra days) to fund your 2006 IRA.
Opening or adding to an existing IRA affords you an important tax advantage.
With traditional plans – providing your adjusted gross income falls within the following ranges – your contributions are entirely tax deductible.
Year Single Filer Joint Filer
2006 $50,000-$60,000 $75,000-$85,000
2007+ $50,000-$60,000 $80,000-$100,000
That means that for 2006 and 2007, you can effectively erase $4,000 from your taxable income and pay taxes just on the remainder. Now maybe $4,000 doesn’t sound like much, but according to this year’s tax tables, that can add up to an extra $1,120 in your bank account if you are in the 28% bracket – enough for a new armchair or a few days in the Bahamas.
Now, even if you don’t meet the above income qualifications, you may still open a traditional, non-deductible IRA or opt for a Roth IRA. Individuals making less than $110,000 and married taxpayers filing jointly who earn less than $160,000 can make at least a partial contribution to a Roth, subject to the same contribution limits as the traditional IRA. And like the traditional IRA, if you are 50 or older, you may make an additional “catch up” contribution of $500 in 2006.
So if it’s not deductible, why bother? Here’s why:
- Your money compounds over time, which makes the next advantage even more important...
- Your earnings and deductible contributions are not taxed until you withdraw the money. And for non-deductible contributions, just part of the withdrawal will be subject to taxation. But there’s one more big plus: Taxes are assessed at ordinary income tax rates, and since you probably won’t be working in your retirement years, your tax bracket should be lower than it is now. Consequently, your tax bite will also be less, probably considerably so.
Bottom line: You can accumulate a significant sum of money from now until age 70 ½, when you will be required to begin withdrawals – money that will most likely be reduced by just minimal taxes at that time.
Now, many investors may think, “I have a company-sponsored 401(k) plan – either through my current or a previous employer(s). Why do I need an IRA?”
One, because an IRA simply helps you accumulate additional retirement monies, complete with the above advantages. 401(k) contributions are also regulated by the government, and most of us realize that we will need a lot more money for our golden years than the amount our 401(k) allows us to save. Therefore, once your 401(k) is funded at the maximum amount each year, start directing your extra money to your IRA.
But, the second reason is an important strategy that many investors often overlook: rolling over an existing 401(k) from a previous employer to a self-directed IRA. I would place a bet (and win!) that most of you have one (or more) of these accounts lingering from an earlier job. And I would further bet that they have substantial sums in them.
You are making a big mistake by leaving your 401(k) monies with an administrator who is probably reducing your account by his management fees – in addition to the expenses and fees you are already incurring in the mutual funds in which your 401(k) is most likely invested. But the fees aren’t the only problem. An even larger disadvantage is this: you have little or no control over your monies left in your old 401(k) plans.
Sure, you can change the options a little; maybe go from a conservative to a more aggressive strategy. But you must stick with the available investments in the plan. Alternatively, you can roll those funds over to an IRA and you will have the option to put your money into virtually any investment you choose – stocks, bonds, mutual funds, ETFs, real estate or commodities.
And… should the market or economy inspire you to alter your investment choices, you can switch them around whenever you desire, not when your previous employer changes administrators and/or 401(k) plans. Best of all – no worrying about capital gains when you make your changes. The tax man doesn’t come knocking until you begin making withdrawals!
Lest you think this is just too much trouble, be assured that it’s as easy as setting up an IRA account at your favorite bank or brokerage house (which is quickly done online), calling your 401(k) administrator to request the transfer form, then completing the form so that your monies are made payable and sent to your new IRA account. Presto! You probably won’t even have to see or handle the money, as most administrators will just send the check directly to your new account. One important note here: make sure the check is made payable to your new account and financial firm – not to you – so that you don’t incur substantial penalties.
If you are self-employed, you have a couple of options that allow even greater annual contributions, and I will cover those in next week’s issue, along with a discussion of the range and type of investments eligible for all of your IRAs.
Suffice it to say, IRAs are a key component of your retirement plan, and the sooner you get started, the better!
Until next week…
This concludes this week's issue of Financially Fit. We encourage you to visit our website to review past issues of Financially Fit:
http://www.brokeradviser.com/newsletter.cfm
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