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Father Time

By: Investor Solutions

By: Investor Solutions

My how time flies! Believe it or not, it is that time of year again. That is, tax filing time when accountants will be scurrying about preparing tax returns until the wee hours of the night (been there, done that). And the time of year when taxpayers all around will be writing Uncle Sam a check for his share of your hard earned work. That’s the bad news. The good news is that you still have time to make contributions to your Individual Retirement Accounts (IRA) for the 2007 tax year. But you only have until April 15th!

Traditional versus Roth

IRAs are excellent retirement savings vehicles that all individuals can take advantage of. There are different kinds, Traditional, Roth, SEP, etc. We will concentrate on Traditional and Roth IRAs at this time. The aggregate 2007 contribution limit for both of these types is the lesser of $4,000 or earned income. For individuals more than 50 years of age, an additional $1,000 catch up contribution is allowed. Traditional IRAs are also known as deductible IRAs because, under certain circumstances, contributions you make can be deducted on your Form 1040. If an individual does not contribute to a retirement plan at work, the full amount under this type of IRA is deductible. However, for individuals who participate in an employee sponsored retirement plan (i.e., 401k), the following phaseouts apply:

If your filing status is Married Filing Jointly, contributions are deductible if your Adjusted Gross Income (AGI) is below $83,000. Between $83,000 and $103,000, only a partial deduction is allowed. If it is in excess of $103,000, it is not deductible.

For single individuals the range is between $52,000 and $62,000.

For Married Filing Separate, individuals with AGI above $10,000 are not allowed a deduction for a Traditional IRA contribution.

Unlike Traditional IRA contributions which may be deductible, Roth IRA contributions never are. However, when the time comes to take distributions from a Roth IRA account, they are done so tax free. In contrast, to the extent that you received a deduction on your taxes for Traditional IRA contributions, upon drawing from your account, those monies will be taxed at your then ordinary income tax rate. Whereas you pay current income taxes on Roth contributions, you, in essence, defer taxes on (deductible) Traditional contributions.

Roth IRA contributions can be made even when a taxpayer participates in their employer sponsored retirement plan. However, income limits apply to Roth IRA contributions. They are as follows:

For single taxpayers, a full Roth IRA contribution can be made if Adjusted Gross Income (AGI) is below $99,000. A reduced contribution is allowed for AGI between $99,000 and $114,000. For individuals with AGI in excess of $114,000, Roth contributions are disallowed.

The income limits for Married Filing Jointly are between $156,000 and $166,000.

Spousal IRA

A great “loophole” with regard to IRA contributions is that of the spousal contribution. Typically, IRA contributions are limited to $4,000 (for 2007) or earned income. For spouses not employed outside of the home with no earned income to speak of, the IRS allows them to piggyback on their working spouses earned income. This allows both spouses to contribute to their own IRAs and help save/contribute to their retirement nest egg. The spouses must file jointly to take advantage of the spousal contribution.

Can $4,000 Make a Difference?

Many individuals might think that $4,000 is a paltry sum. Perhaps. But given years to grow and compounding interest, annual contributions to an IRA can prove lucrative at retirement. Here is how contributions would grow assuming you contributed $4,000 per year, earned an 8% rate of return and retired at the age of 65:

$1,546,022 if you started when you were 20 years old

$ 689,267 if you started when you were 30 years old

$ 292,424 if you started when you were 40 years old

$ 108,608 if you started when you were 50 years old

$ 23,466 if you started when you were 60 years old

Obviously the earlier you start the more you will accumulate. These simple examples also do not take into account increasing contribution limits ($5,000 for 2008) and catch up contributions ($1,000 for 2008) after the age of 50.

Where’s the Money?

For individuals who want to save more for retirement but have fallen on hard times financially speaking, it can be difficult and maybe even impossible to “find” an additional $4,000. But there is hope, for this year at least. The United States Treasury will begin sending out economic stimulus payments this May to more than 130 million taxpayers. Why not use those monies to fund your IRA contribution? Or direct deposit your refund, if you’re that lucky, into an appropriate IRA account.

Whether you have been in the workforce for years or are just starting out, IRAs can be an important tool in helping you fund your golden years. Take advantage of the years that you have to save and remember that Father Time is on your side.