Does an IRA Still Make Sense?

Reasons to consider investing in one

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Roger Wohlner

A recent survey by TIAA-CREF showed that:

  • 38 percent of Americans who currently own an IRA account contribute up to the maximum amount allowed
  • 55 percent of those IRA owners are contributing less than the maximum amount.
  • 76 percent of those polled said they are not contributing to an IRA at all.
  • Clearly, the IRA has lost much of its popularity as a retirement savings vehicle. Should an IRA be a part of your retirement savings strategy? The answer is that it depends.

    First fund your 401(k) or 403(b) at least enough to receive any company match. Though not all company retirement plans offer great investments and many assess high fees, I’ve not yet seen a plan that is so bad that I’ve recommended that a client forgo funding the plan to a level that provides them with the maximum company match. For example, if your employer matches 50 percent for each dollar you contribute up to a 6 percent salary deferral, this mean that you are getting a 50 percent return on your investment. Of course, not all 401(k) or 403(b) plans offer a match, so you will want to learn all of the details here.

    Salary deferral into a company retirement plan is painless. Regardless of whether your company provides a match or not, it still might make sense to contribute to your plan. It might also make sense to contribute over and above the maximum amount that is matched. Salary deferrals are easy, and once you start, you rarely miss the money in your paycheck.  Many studies have concluded that the key factor in the amount most workers accumulate at retirement is the amount saved.

    Beyond the two situations above, an IRA can still be a useful vehicle in your retirement savings strategy. Here are some examples:

    A non-working spouse can make a deductible IRA contribution under certain circumstances. A spousal IRA allows a non-working spouse to contribute up to the maximum ($5,000 if under 50; $6,000 if 50 or older) as long as the working spouse has enough earned income to fund this contribution. Assuming the working spouse is covered by a retirement plan at work, the ability to make a deductible spousal IRA contribution phases out between $173,000 and $183,000 in AGI in 2012.

    You aren’t covered by a workplace retirement plan. Perhaps your company doesn’t offer a retirement plan, or perhaps you are self-employed. Funding an IRA is a great start. Remember, though, once your business starts to generate sufficient income, there are many retirement savings vehicles for the self-employed that allow you to contribute far more than an IRA does.

    IRAs can make a great rollover destination for your retirement plan balance when leaving your employer. Anytime you leave a job, you have a decision to make regarding your retirement plan balance. Generally, the three options are leaving your balance with your old employer’s plan, rolling your balance to your new employer’s plan (if allowed and if you are moving to another job), or rolling into an IRA. You can also take an outright distribution, but this is usually not a good option considering the income tax implications and potential penalties. An IRA can offer advantages such as a broader array of available investment options and in some cases lower investing costs.

    An IRA can be a good solution for consolidating several old 401(k) accounts. It is not uncommon for workers to have five of more employers over the course of a career. This can often lead to a stream of old, unwatched 401(k) accounts with former employers, or as I call it, retirement clutter. Rolling these old accounts into a single IRA account can help simplify managing these assets as part of your overall portfolio.

    In addition to your company’s retirement plan. Perhaps your plan is just average and you’d like to direct additional contributions over and above the amount needed to gain the full match to an IRA where you can find better investment options. Or perhaps you are maxing out your company’s plan and want a place to make additional retirement savings contributions. An IRA might be the right answer for you.

    Some IRA basics. An IRA allows you to contribute the lesser of $5,000 ($6,000 if 50 or over) or the amount of your earned income. Income from investments, interest, and other non-earned income doesn’t count. Deductibility of your contribution to a traditional IRA depends upon your level of earned income, whether or not you or your spouse is covered by a retirement plan at work, and other factors. If you are not able to deduct any or some of your contribution, you can generally still contribute to a non-deductible IRA. Of course, there is always the Roth option.  Here, contributions are after-tax, but if you meet the requirements, you can generally withdraw your account balance free of tax. Which “flavor” of IRA is right for you will depend upon your own unique individual situation.

    An IRA can be a useful tool as you save for retirement. Your best bet is to look at your overall situation and decide if and where an IRA fits into your overall strategy.

    Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Roger also blogs at Chicago Financial Planner.