The Importance of Saving for your Retirement
Courtesy Empire Bank, Springfield LIVING WELL Magazine
Throughout the years, Congress has made changes to the rules on individual retirement accounts (IRAs) in hopes of making it easier for individuals to save for their own retirement by offering expanded tax incentives. This series of changes, along with the introduction and increased popularity of Roth IRAs, has left many with questions about their eligibility to contribute to an IRA, the types of IRAs to which they can contribute, and how much they are able to contribute.
An IRA is a long-term savings tool specifically intended for retirement savings. With growing uncertainty about the future of Social Security and the dwindling number of employers offering Traditional pension plans, it is becoming more important for individuals to save for their own retirement. IRAs are also good tools to use when you’ve maxed out your 401k contributions for the year but still want to save more toward retirement. IRAs also provide individuals the opportunity to diversify their retirement savings if they have limited investment options in their 401k plan. In addition, investors commonly add IRAs to their retirement portfolio mix when they’ve changed jobs and need to roll over a 401k, which can be done to avoid paying early withdrawal penalties and taxes. IRAs come in several variations, with the most common being the Traditional IRA and the Roth IRA.
With both Traditional and Roth IRAs, contributions for a given year can be made up to the deadline for filing your federal income tax return for that year—not including extensions. For 2011, the maximum contribution was $5,000. The maximum contribution in 2012 is also $5,000. In addition, if you will reach age 50 before the end of the year, you are entitled to make an additional $1,000 “catch-up” contribution to your IRA.
Contributions can be made to a Traditional IRA, Roth IRA, or both, as long as the total contribution doesn’t exceed the maximum allowed in any given year. There are additional restrictions on eligibility to make a contribution to an IRA. In order to contribute to a Traditional IRA, you must have income at least equal to the amount of the IRA contribution you are making. This income must be from work of some type; it cannot include interest income, disability income, rental income, or any other type of income aside from work. Individuals also cannot contribute to a Traditional IRA if they will reach age 70 ½ before the end of the year. In order to contribute to a Roth IRA, the same provision regarding income from work is in place. There is no age restriction on making Roth IRA contributions; however, there are some restrictions according to income level. For 2011, a full contribution could be made to a Roth IRA if the individual’s modified adjusted gross income (MAGI) was no more than $169,000 (married people filing jointly) or $107,000 (singles). Partial contributions were allowed for MAGIs between $169,000 and $179,000 (married/joint), or between $107,000 and $122,000 (singles). Due to rule changes that eliminated income restrictions for conversions of a Traditional IRA to a Roth, it is now possible for individuals who have too much income to contribute to a Roth IRA to make a “back-door” contribution to a Roth IRA by making a nondeductible contribution to a Traditional IRA, then subsequently converting it to a Roth IRA. Individuals wanting to do this should seek advice from a tax professional prior to making the contributions.
IRA contributions can also be made for a non-working spouse. As long as a joint return is filed, a spousal IRA may be set up, making contributions up to the same maximum allowed for the working spouse. The extra age-dependent $1,000 catch-up contribution may also be made on behalf of the non-working spouse if they are 50 or older, even if he or she has no income from employment.
If an individual participates in a company retirement plan, they may be able to deduct contributions to a Traditional IRA. Deductibility is dependent upon the MAGI and tax filing status. A full deduction is allowed for 2011 contributions when the MAGI is no more than $90,000 (for married people filing jointly) or $56,000 (for singles). If an individual is not covered by an employer retirement plan, they may generally take a full deduction of Traditional IRA contributions, regardless of their income. There is no tax deduction available for Roth IRA contributions.
Withdrawals from a Traditional IRA are reported as regular income and are taxable at the individual’s income tax rate. If an individual withdraws money from a Traditional IRA before reaching the age of 59 ½, they may be subject to a 10% penalty on the funds withdrawn. Withdrawals of contributions to a Roth IRA are not taxed, as the funds have already been taxed. Withdrawal of earnings in a Roth IRA may be subject to taxation and/or penalty depending upon the length of time the Roth IRA has been open and the age of the individual. There are some exceptions that will allow individuals to avoid penalties on early withdrawals from an IRA.
Another important difference between a Traditional IRA and a Roth IRA is that once an individual reaches age 70 ½, they must begin withdrawing a minimum amount each year from their Traditional IRA. The amount is determined by a standardized factor based on their age and the balance in the account. Roth IRAs have no minimum distribution requirement. The funds can remain in the account and continue to grow until needed.
For more information about which IRA is right for you, contact Kevin Laws at Empire Bank. Kevin is a Certified IRA Services Professional (CISP). Call 417-881-3100 or visit www.empirebank.com.