| |
IRAs are a great deal for lots of reasons. First, they are widely available. Anyone who has income from a paying job can have one, so you don't have to depend on your employer to offer a pension plan; you can start your own. A couple of provisions make IRAs particularly attractive to women: If you are a stay-at- home spouse without an income and your husband is employed, he can stash money in an IRA for you, so you can have your own retirement plan. Also, alimony payments count as income for purposes of opening an IRA.
Second, money you put into the account grows tax-deferred. That means you don't have to pay tax on the earnings as they accrue, so more of your money is working on your behalf. In the preceding section, we saw that if you begin contributing $4,000 a year to an IRA starting at age 40 and earn 8% a year, you'd have about $305,000 by age 65. But if the earnings were taxed annually in the 25% bracket, the account would grow to only about $225,000.
In fact, the biggest decision you'll have to make is not whether to open an IRA, but which kind to open-a traditional IRA or a Roth IRA. A traditional IRA often offers the bonus of an instant tax deduction. Money you contribute to a Roth IRA is not tax-deductible, but withdrawals in retirement are tax-free. Generally speaking, the Roth is the better choice, if you're eligible. Let's review some basics.
WHICH IRA, ROTH OR TRADITIONAL?
You can make a contribution to a traditional IRA no matter how much you earn, but the opportunity to use a Roth is phased out as your adjusted gross income (AGI) rises from $95,000 to $110,000 on a single return and $150,000 to $160,000 on a joint return. (AGI is basically taxable income before deductions and exemptions are subtracted.) While many individuals can deduct contributions to traditional IRAs, no one can write off Roth deposits.
With both IRA varieties, earnings on the money you invest are protected from the IRS while they're inside the account.
However, every dime coming out of a traditional IRA will be taxed (except to the extent that it represents a nondeductible contribution, as explained below), while cash coming out of a Roth is almost sure to be tax-free. Two tests determine whether you can deduct contributions to a traditional IRA:
1. Are you covered by a retirement plan at work? If not, you can deduct your contributions, no matter how much you make.
2.What is your income? If you have a retirement plan at work, your right to the deduction disappears as your income rises. A higher phaseout zone applies if your spouse is covered by a retirement plan but you are not.
If you can't deduct regular IRA contributions, the Roth is definitely a better deal for you if you qualify. Even if you can, it almost surely makes sense to skip the deduction and choose the Roth, as the following discussion shows.
A big unknown is what your tax bracket will be when you retire; that's critical to knowing which IRA will be better for you. All other things being equal, if you will be in a higher tax bracket in retirement, the Roth will prove to be a winner. You're passing up a tax deduction at your lower tax rates today for a tax benefit when your tax rates will be higher. Even if you end up in the same tax bracket when you retire as you are in now, you'll still probably be better off with the Roth. If your tax rate will be lower when you retire, that's a tougher call. But other attributes of a Roth can tip the balance in its favor:
- You can withdraw the total of your annual contributions at any time without incurring a penalty or tax. Note that this rule applies only to your Roth contributions, not to earnings. If your withdrawals reach the point at which you're dipping into earnings, you may owe both taxes and a 10% penalty if you're under age 591/2. But even here there are attractive exceptions. After the account has been in existence for 5 years, you can withdraw up to $10,000 in earnings for the purchase of a new home (for you, your spouse, your kids, your grandchildren, or your parents), and both the tax and penalty will be waived. You can also withdraw earnings to pay college bills without paying a penalty, although you will have to pay taxes on the amount of the earnings that you withdraw unless you are over 591/2.
- You can make contributions at any age, and you never have to withdraw funds. With a regular IRA, contributions must end at age 701/2 and withdrawals must begin.
- Roth withdrawals cannot cause social security benefits to be taxed; traditional IRA withdrawals can cause that to happen.
- The balance in a Roth IRA goes to heirs income-tax-free, whereas the balance in a traditional IRA is taxed to your heirs in their top tax bracket.
A RETIREMENT PLAN FOR STAY-AT-HOME MOMS. One of the great features of an IRA is that you can have one even if you don't have a paying job, as long as your spouse is employed. In that case, he can also contribute up to $4,000 of his compensation to an account for you. You can open either a traditional or a Roth IRA, depending on your joint incomes. If you open a traditional IRA, you can usually deduct the contribution to the spousal account even if the contribution to the worker's account can't be written off. (If your husband is covered by a retirement plan at work, your spousal IRA deductions are limited by the income test, but a much higher income limit applies to spousal IRAs: A contribution to a spousal account can be fully deducted as long as AGI is under $150,000; a partial deduction is allowed until income hits $160,000.)
You can pass up the deduction altogether and open a spousal Roth IRA. Or you and your husband can hedge your bets and open one of each, traditional and Roth. The point is, you can- and should-have your own retirement savings even if you don't have a paying job outside the home. What's more, you can-and should-manage the money yourself .
|
