Understanding IRA's

[BuckStocksHere]

I was reading the saving for retirement thread and thought this might be of use to some of you. If not, just disregard the long read.


An individual retirement account (IRA) is a personal savings plan that offers specific tax benefits. IRAs are one of the most powerful retirement savings tools available to you. Even if you're contributing to a 401(k) or other plan at work, you should also consider investing in an IRA.


The two major types of IRAs are traditional IRAs and Roth IRAs. Both allow you to contribute as much as $4,000 in 2005 through 2007 (the annual IRA contribution limit increases to $5,000 in 2008). You must have at least as much taxable compensation as the amount of your IRA contribution. But if you are married filing jointly, your spouse can also contribute to an IRA, even if he or she does not have taxable compensation. The law also allows taxpayers age 50 and older to make additional "catch-up" contributions. These folks can put $4,500 into their IRAs for 2005, and up to $5,000 in 2006 and 2007 (increasing to $6,000 per year in 2008).
Both traditional and Roth IRAs feature tax-sheltered growth of earnings. And both give you a wide range of investment choices. However, there are important differences between these two types of IRAs. You must understand these differences before you can choose the type of IRA that's best for you.
Note: Unless extended, the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 relating to IRA contributions will expire at the end of 2010. For tax years beginning after December 31, 2010, the contribution rules and limits that existed prior to the 2001 tax act would apply.


Practically anyone can open and contribute to a traditional IRA. The only requirements are that you must have taxable compensation and be under age 70½. You can contribute the maximum allowed each year as long as your taxable compensation for the year is at least that amount. If your taxable compensation for the year is below the maximum contribution allowed, you can contribute only up to the amount that you earned.
Your contributions to a traditional IRA may be tax deductible on your federal income tax return. This is important because tax-deductible (pretax) contributions lower your taxable income for the year, saving you money in taxes. If neither you nor your spouse is covered by a 401(k) or other employer-sponsored plan, you can generally deduct the full amount of your annual contribution. If one of you is covered by such a plan, your ability to deduct your contributions depends on your annual income (modified adjusted gross income, or MAGI) and your income tax filing status. You may qualify for a full deduction, a partial deduction, or no deduction at all.
What happens when you start taking money from your traditional IRA? Any portion of a distribution that represents deductible contributions is subject to income tax because those contributions were not taxed when you made them. Any portion that represents investment earnings is also subject to income tax because those earnings were not previously taxed either. Only the portion that represents nondeductible, after-tax contributions (if any) is not subject to income tax. In addition to income tax, you may have to pay a 10 percent early withdrawal penalty if you're under age 59½, unless you meet one of the exceptions.
If you wish to defer taxes, you can leave your funds in the traditional IRA, but only until April 1 of the year following the year you reach age 70½. That's when you have to take your first required minimum distribution from the IRA. After that, you must take a distribution by the end of every calendar year until you die or your funds are exhausted. The annual distribution amounts are based on a standard life expectancy table. You can always withdraw more than you're required to in any year. However, if you withdraw less, you'll be hit with a 50 percent penalty on the difference between the required minimum and the amount you actually withdrew.


Not everyone can set up a Roth IRA. Even if you can, you may not qualify to take full advantage of it. The first requirement is that you must have taxable compensation. If your taxable compensation for the year is at least $4,000 (for 2005 through 2007), you may be able to contribute the full $4,000. But it gets more complicated. Your ability to contribute to a Roth IRA in any year depends on your MAGI and your income tax filing status. Your allowable contribution may be less than the maximum possible, or nothing at all.
Your contributions to a Roth IRA are not tax deductible. You can invest only after-tax dollars in a Roth IRA. The good news is that those contribution amounts will be income tax free when you withdraw them. Better yet, if you meet certain conditions, your withdrawals from a Roth IRA will be completely income tax free, including both contributions and investment earnings. To be eligible for these qualifying distributions, you must meet a five-year holding period requirement. In addition, one of the following must apply:

• You have reached age 59½ by the time of the withdrawal
• The withdrawal is made because of disability
• The withdrawal (of up to $10,000) is made to pay first-time home-buyer expenses
• The withdrawal is made by your beneficiary or estate after your death

Qualifying distributions will also avoid the 10 percent early withdrawal penalty. This ability to withdraw your funds with no taxes or penalties is a key strength of the Roth IRA. And remember, even nonqualifying distributions will be taxed (and possibly penalized) only on the investment earnings portion of the distribution, and then only to the extent that your distribution exceeds the total amount of all contributions that you have made.
Another advantage of the Roth IRA is that there are no required distributions after age 70½ or at any time during your life. You can put off taking distributions until you really need the income. Or, you can leave the entire balance to your beneficiary without ever taking a single distribution. Also, as long as you have taxable compensation and qualify, you can keep contributing to a Roth IRA after age 70½.


Assuming you qualify to use both, which type of IRA is best for you? Sometimes the choice is easy. The Roth IRA will probably be a more effective tool if you don't qualify for tax-deductible contributions to a traditional IRA. However, if you can deduct your traditional IRA contributions, the choice is more difficult. Most professionals believe that a Roth IRA will still give you more bang for your dollars in the long run, but it depends on your personal goals and circumstances. The Roth IRA may very well make more sense if you want to minimize taxes during retirement and preserve assets for your beneficiaries. But a traditional deductible IRA may be a better tool if you want to lower your yearly tax bill while you're still working (and probably in a higher tax bracket than you'll be in after you retire). A financial professional or tax advisor can help you pick the right type of IRA for you.
Note: You can have both a traditional IRA and a Roth IRA, but your total annual contribution to all of the IRAs that you own cannot be more than $4,000 for 2005 through 2007 ($4,500 in 2005, $5,000 in 2006 and 2007, if age 50 or older).


You can move funds from an IRA to the same type of IRA with a different institution (e.g., traditional to traditional, Roth to Roth). No taxes or penalty will be imposed if you arrange for the old IRA trustee to transfer your funds directly to the new IRA trustee. The other option is to have your funds distributed to you first and then roll them over to the new IRA trustee yourself. You'll still avoid taxes and penalty as long as you complete the rollover within 60 days from the date you receive the funds.
You may also be able to convert funds from a traditional IRA to a Roth IRA if your MAGI for the year is $100,000 or less. This decision is complicated, however, so be sure to consult a tax advisor. He or she can help you weigh the benefits of shifting funds against the tax consequences and other drawbacks.
Note: The IRS has the authority to waive the 60-day rule for rollovers under certain limited circumstances, such as proven hardship.


All that being said, I am not a tax advisor and would highly recommend consulting one if you have further questions. I think the basics are covered here pretty well but if you have any questions, I'm sure some of us can try to help. That's what this 'planet is all about right? (like you know, how to fix a house when you put holes in it! )

 

[BuckStocksHere]

HERE IS SOME INFO ON YEAR END TAX PLANNING. (again, I am not a tax advisor..seek one if you need further assistance)



As the end of the year approaches, it's time to consider strategies that can help you reduce your tax bill. But most tax tips, suggestions, and strategies are of little practical help without a good understanding of your current tax situation. This is particularly true for year-end planning. You can't know where to go next if you don't know where you are now.
So take a break from the usual fall chores and pull out last year's tax return, along with your current pay stubs and account statements. Doing a few quick projections will help you estimate your present tax situation and identify any glaring issues you'll need to address while there's still time.
When it comes to withholding, don't shortchange yourself
If you project that you'll owe a substantial amount when you file this year's income tax return, ask your employer to increase your federal income tax withholding amounts. If you have both wage and consulting income and are making estimated tax payments, there's an added benefit to doing this: Even though the additional withholding may need to come from your last few paychecks, it's generally treated as having been withheld evenly throughout the year. This may help you avoid paying an estimated tax penalty due to underwithholding.
Of course, if you've significantly overpaid your taxes and estimate you'll be receiving a large refund, you can reduce your withholding accordingly, putting money back in your pocket this year instead of waiting for your refund check to come next year.
Will you suffer the alternative?
Originally intended to prevent the very rich from using "loopholes" to avoid paying taxes, the alternative minimum tax (AMT) snags more and more middle-income taxpayers every year, since (unlike regular income tax) it doesn't keep pace with inflation. The AMT is governed by a separate set of rules that exist in parallel to those for the regular income tax system. These rules disallow certain deductions and personal exemptions that you are allowed to include in computing your regular income tax liability, and treat specific items, such as incentive stock options, differently. As a result, AMT liability may be triggered by such items as:

• Large numbers of personal exemptions
• Large deductible medical expenses
• Large deductions for state, local, personal property, and real estate taxes
• Home equity loan interest where the financing isn't used to buy, build, or improve your home
• Exercising a large incentive stock option
• Large amounts of miscellaneous itemized deductions such as unreimbursed employee business expenses

So when you sit down to project your taxes, calculate your regular income tax on Form 1040, and then consider your potential AMT liability using Form 6251. If it appears you'll be subject to the AMT, you'll need to take a very different planning approach during the last few months of the year. Even some of the most basic year-end tax planning strategies can have unintended consequences under AMT rules. For example, accelerating certain deductions into this year may prove counterproductive since AMT rules may require you to add them back into your income. See a tax professional for information on your specific tax situation.
Timing is everything
The last few months of the year may be the time to consider delaying or accelerating income and deductions, taking into consideration the impact on both this year's taxes and next. If you expect to be in a different tax bracket next year, doing so may help you minimize your tax liability. For instance, if you expect to be in a lower tax bracket next year, you might want to postpone income from this year to next so that you will pay tax on it next year instead. At the same time, you may want to accelerate your deductions in order to pay less tax this year.
To delay income to the following year, you might be able to:

• Defer compensation
• Defer year-end bonuses
• Defer the sale of capital gain property (or take installment payments rather than a lump-sum payment)
• Postpone receipt of distributions (other than required minimum distributions) from retirement accounts

To accelerate deductions into this year:

• Consider paying medical expenses in December rather than January, if doing so will allow you to qualify for the medical expense deduction
• Prepay deductible interest
• Make alimony payments early
• Make next year's charitable contributions this year

The gifts that give back in return
If you itemize your deductions, consider donating money or property to charity before the end of the current tax year in order to increase the amount you can deduct on your taxes. As an aside, now is also a good time to consider making noncharitable gifts. You may give up to $11,000 ($22,000 for a married couple) to as many individuals as you want without incurring any gift tax consequences. If you gift an appreciated asset, you won't have to pay tax on the gain; any tax is deferred until the recipient of your gift disposes of the property.
Postpone the inevitable
To reduce your taxable income this year, consider maximizing your contributions to an employer-sponsored retirement plan such as a 401(k). You won't be taxed on the contributions you make now, and you may be in a lower tax bracket when you do eventually withdraw the funds and report the income.
If you qualify, you might also consider making either a tax-deductible contribution to a traditional IRA or an after-tax contribution to a Roth IRA. In the first instance, a current income tax deduction effectively defers income--and its taxation--to future years; in the second, while there's no current tax deduction allowed, qualifying distributions you take later will be tax free. You'll generally have until the due date of your federal income tax return to make these contributions.

 

[Buckin' A]

Funny this was brought up. I just met with a friend of mine Friday night about setting up college funds for my kids. We talked mainly about the Coverdell and 529 IRA's for them.

The main difference between the two is that with the Coverdell, you can only put $2000.00 or less in per year. Witht the Coverdell, you can use it tax free for any education related expense, even in High School (such as private school, exchange student expenses, etc...)

With the 529, you can contribute as much as you want in one year, but you can only use it tax free once your children go to college.

Both of these can be transfered down to other children if not used by the one they were taken out for. Or, once that child reaches age 30, they can pass it on to their own child-or- pull the money out for a 10% fee, plus taxes.

Both are great options. I have 3 children and whatever I can do to help them should be done. Experts are saying that student loans will be gone in the next five years.

Food for thought.

 

[gbearbuck]

Experts are saying that student loans will be gone in the next five years.

I doubt that... many folks don't save for their own retirement, why on earth would they save for their kids college, that's the kids problem isn't it?:tongue2:

Many families strugle to make ends meet right now... I doubt they can "afford" (subjective) the extra expense... worry about it later...

 

[Thump]

So is me keeping my money in a tootsie roll cannister under my bed a bad thing?

 

[Buckin' A]

I doubt that... many folks don't save for their own retirement, why on earth would they save for their kids college, that's the kids problem isn't it?:tongue2:

...

Unfortunately, that's the way some people think. The government has given us "earning tax exempt" ways to plan for college. My sister in law, who is a teacher, says that in 5 years student loans will be few and far between.

Thump, you hearing anything about this?

 

[Thump]

Thump, you hearing anything about this?

I haven't heard anything like that.

 

[Buckin' A]

Sounds like the teacher needs to be taught.