In an effort to encourage us to save for our own retirement rather than depend on the government and programs like Social Security, Congress has passed laws providing opportunities for us to save for our own retirement in a tax-advantaged way. Perhaps the two best ways to do this for most people are the IRA and the 401(k). When it comes to retirement planning, the IRA offers tremendous opportunities. As always, there is a veritable avalanche of rules that can be viewed by pessimists as stifling complications. However, to the optimist, these rules present opportunities to help you adapt an IRA strategy that will work best for you and your family.
IRA is an acronym for Individual Retirement Account. It comes in the form of the traditional IRA (if anything that has only been around since 1974 can be referred to as traditional) and the Roth IRA, named after its primary Congressional proponent, Delaware Senator William Roth. The traditional IRA was originally intended to provide a means for people who were not covered by company pensions to be able to save for their own retirement in a tax-advantaged manner. In 1981, Congress broadened the availability of IRAs to all workers regardless of whether they were covered by a company pension.
The Roth IRA became law in 1997. Two years prior to its enactment, a similar proposal entitled the American Dream Savings Account was passed by Congress but vetoed by then-President Clinton. Apparently, they did not share the same dream. The Roth IRA was the crowning achievement of the legislative career of Senator William Roth, who a scant three years after the passage of the legislation was sent into his own retirement when he lost his bid for reelection to the Senate.
With a traditional IRA, contributions to the IRA are often tax deductible and accumulate income on a tax-deferred basis. With a Roth IRA, you pay income tax on the money you put into the IRA. However, the money grows untaxed, and you are able to take money out of a Roth IRA free of all income taxes.
A traditional IRA is a retirement account into which the law permits you to make, in many cases, tax-deductible contributions on an annual basis of as much as $5,000. For those of you reaching the age of 50, not only do you get a birthday card from AARP (and how do they always manage to know when everyone’s 50th birthday is?), but also you are permitted by law to contribute an extra $1,000 to your IRA, for an annual total of $6,000. Beginning in 2009, the amount of the annual contributions are adjusted annually for inflation, in $500 increments.
Perhaps the major requirement for eligibility for any IRA is earned income. However, there are limitations on the amount of income you may have to qualify for a Roth IRA. There is no limitation on the amount of income you are permitted to earn to be eligible for a traditional IRA. In addition, you must be under the age of 70 1/2 to contribute to an IRA, but more on that later.
If you are married and neither you nor your spouse has a retirement plan at work, your contributions to your traditional IRAs will be fully tax deductible in that year. Even if you do have a retirement plan at work, you may be able to deduct some or even all of your IRA contributions if your taxable income meets certain guidelines. For 2008, the guidelines were particularly restrictive for married people filing separate income tax returns. Couples are allowed to have no more than $10,000 of adjusted gross income to get even a partial tax deduction for their contributions to traditional IRAs. Single or head of household filers could fully deduct their contributions to a traditional IRA if their adjusted gross income was less than $53,000. They were able to receive a partial deduction for their contributions if their adjusted gross income was between $53,000 and 63,000. Married couples filing a joint income tax return get the most bang for their bucks from Uncle Sam, who permitted them to fully deduct their IRA contributions so long as their adjusted gross income was less than $85,000. They could receive a partial deduction if their adjusted gross income was between $85,000 and 105,000. Husbands and wives are each permitted to have their own individual IRA accounts even if only one spouse is working outside the home.
To make things even more complicated (and isn’t that the apparent job of government?), if one member of a married couple is an active participant in a pension plan at work, the other spouse may still deduct all of his contribution to a traditional IRA so long as the couple’s combined adjusted gross income was less than $159,000 in 2008. A partial deduction for the contributions to a traditional IRA by the spouse not covered by a pension plan at work was allowed when the couple’s combined adjusted gross income was between $159,000 and $169,000. At $169,000 of combined income, no deduction was permitted for a contribution to a traditional IRA for the spouse not covered by a pension at work.