With tax season upon us, this seems like a good time to review the IRA as a potential retirement savings vehicle, since you still have a few days to make 2012 contributions.
According to a survey by financial services firm TIAA-CREF: “Eighty percent of those surveyed said they are not contributing to an IRA, up 4 percent from last year. Close to half also lack basic understanding of what IRAs are and how they are used.”
Contributions to a 2012 IRA can be made up to the April 15 filing deadline. There are two types of IRAs: Traditional and Roth. Some characteristics of a traditional IRA:
- Investments grow tax-deferred until withdrawn. Except for any after-tax contributions, the full value of funds withdrawn is taxed at ordinary income tax rates.
- Contributions may be fully tax deductible if neither you nor your spouse is covered by a retirement plan at work such as a 401(k).
- If you or your spouse is covered by a retirement plan at work there are income limits over which contributions are not deductible. For 2012 this is modified gross income of $58,000 with a phase-out going up to $68,000.
- If you are married but not covered by a retirement plan there are separate limits for a deductible spousal IRA.
- If you earn too much to deduct your traditional IRA contribution you can still contribute on an after-tax basis. Your money will grow tax-deferred until withdrawal. The portion that was contributed after-tax will not be taxed upon withdrawal.
Roth IRAs have gained in popularity in recent years. Contributions are made on an after-tax basis but the money comes out of your account tax-free provided certain requirements are met. The two main requirements are that the initial Roth IRA contribution was made at least five years ago and that you are at least 59 ½. Some other Roth tips:
- There are income limitations here as well.
- For single filers the 2012 phase-out for contributions starts at $110,000 of modified adjusted gross income; for those who are married filing jointly at begins at $173,000.
- There are much lower limits for those who are married but file separately.
Note that for both the Roth and traditional IRAs the income ceilings referenced above have increased for 2013 contributions. The contribution limits for 2012 are $5,000 with an additional $1,000 for those who were 50 or older during 2012. For 2013 the contribution limits are $5,500 plus the additional $1,000 for those 50 and over.
When should you consider an IRA contribution?
Certainly anyone who can afford to do so should consider contributing to an IRA in some form. If you are not covered by a workplace retirement plan this is a great retirement savings vehicle. If your 401(k) is pretty lousy you might consider contributing up to the amount needed to capture any match offered and then funding an IRA. For a non-working spouse, a Spousal IRA can be a great way to continue to save for retirement.
Other IRA considerations.
If you are opening your first IRA account or looking to switch custodians for an existing account, shop around. Fidelity, Schwab, ETrade and others want your money. Look at things like account fees, transaction fees, and the menu of investment choices offered.
Remember an IRA is a type of account, not an investment. I can’t tell you how many times over the years I've had someone ask something like, “What type of rate can I get for an IRA.” Except for a few restrictions you can typically invest in most standard financial and investment vehicles such as ETFs, mutual funds, stocks, bonds, and CDs.
Other IRA flavors.
The SIMPLE IRA is an easy to establish vehicle for small employers without another retirement plan such as a 401(k) for themselves and their employees. There are a number of restrictions here such as the fact that this has to be the only plan offered by your company.
The SEP-IRA can be a great tool for the self-employed. These have many of the same features as traditional IRA accounts, but with higher contribution limits which up to a maximum of the lesser of 25 percent of the owner’s compensation or $50,000 ($51,000 for 2013). A SEP-IRA for 2012 can be opened and funded by your tax filing date, including extensions. Note that a SEP-IRA can be used with employees as well, but this can get quite expensive for a business owner pretty quickly. Also, new salary deferral SEPs are no longer available.
While the above is a summary rather than a complete list of rules and limitations, an IRA can often be a solid retirement planning tool.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.