IRA Tax Time

Tax Season: A perfect time to think about an IRA

With tax day looming, it’s a great time to review your current retirement savings strategies and make any changes that are necessary in an effort to keep your plan on track for long-term financial security. This time of year is also a perfect time to start an IRA if you haven’t done so already.

The IRS allows contributions to an IRA up to April 15, 2014 for the 2013 tax year.

There are two types of IRAs available: a traditional IRA and a Roth IRA. The principal difference between the two is the tax treatment of contributions and distributions or withdrawals.

The traditional IRA may allow a tax deduction based on your contribution, depending on your income level. Earnings on this type of account compound on a tax-deferred basis. In other words, distributions are taxable at the time of withdrawal at the then-current income tax rates.

The Roth IRA doesn’t allow a deduction for contributions. However, earnings and qualified withdrawals are tax-free.

When deciding whether a traditional IRA or a Roth IRA is the right choice for you, you need to weigh the immediate benefit of the tax deduction and earnings that compound on a tax-deferred basis against tax-free distributions in retirement.

If you need the tax deduction to help lower your tax bill this year – and you qualify for it – then you may want to opt for the traditional IRA.

To qualify for the full annual IRA deduction in 2013, you must either: 1. Not be eligible to participate in a company retirement plan, or 2. If you are eligible, you must have an adjusted gross income of $59,000 or less for singles, or $95,000 or less for married couples filing jointly. If you are not eligible for a company plan but your spouse is, your traditional IRA contribution is fully deductible as long as your combined gross income does not exceed $178,000.

If you are covered by a retirement plan at work, your 2013 deduction will be reduced if your modified adjusted gross income (MAGI) is:

Between $95,000 and $115,000 for a married couple filing a joint return for the 2013 tax year.
Between $59,000 and $69,000 for a single individual or head of the household for the 2013 tax year.

You must also consider the tax bracket you think you will be at retirement. If you expect your tax bracket to drop considerably and you qualify for the deduction, the traditional IRA may be the better choice.

If, based on the scenarios above, you don’t qualify for the deduction and/or you expect that your tax bracket will not be significantly lower; a Roth IRA may be the better option.

You should maximize your IRS allowable contributions if financially possible. The maximum is $5,500 per individual, plus an additional $1,000 annually if you are aged 50 and older for 2013. Note, those amounts are per individual not per IRA.

Not everyone can afford to maximize his/her annual IRA contribution, especially if you are already contributing to an employer retirement plan. If your workplace plan offers an employer’s matching contribution, then this “free” money may be more of an incentive to than the annual IRA deduction. If this is the case, it may make more sense to maximize the employer matched plan first and then try to maximize your contributions to your IRA.

The important takeaway from this information is that you shouldn’t hesitate to use the remaining time between now and April 15 to contribute or start an IRA. The ability for you to live comfortably in retirement depends on it.

Note: The above article is intended to provide generalized financial information for educational purposes only. It is not intended to give personalized tax, investment, legal or other business or professional advice. Before taking any action, you should always seek the assistance of a professional.