By Edward Reilly CRPC, CMFC
If your palms get sweaty thinking about how you are going to fund your retirement, take heart. New Individual Retirement Account (IRA) tax rules -- particularly those pertaining to the Roth IRA -- offer more flexibility to help you sock away money with tax advantages.
How do traditional IRAs and Roth IRAs differ? A traditional IRA is funded with pre-tax dollars and your tax bill is deferred until the money is withdrawn in retirement, when you may be in a lower tax bracket. Contributions to a traditional IRA reduce your taxable income if you are qualified for a deductible contribution. A Roth IRA on the other hand, is usually funded with after-tax dollars. Because the tax bill is already paid, the Roth owner can generally look forward to withdrawing earnings federal tax-free at age 59 1/2. The Roth IRA has been off limits to investors with high modified adjusted gross incomes, but stay tuned for new rules that broaden eligibility, assuming the five year rule has been met.
Despite certain limitations, both IRAs offer a way to save for the future while preserving your flexibility to access your money in certain circumstances. For example, you can withdraw from your IRA savings without penalty prior to retirement to pay for qualified higher education expenses or to make a down payment on a first home. Plus, recent IRA contribution limit increases allow you to save more toward retirement; with provisions to help older investors catch up if they started saving late in the game. In 2008, you can save $5,000 annually in an IRA and an additional $1,000 if you are 50 or older.
Converting savings from a traditional IRA to a Roth IRA makes sense if your contributions are not deductible because you or your spouse are participating in an employer plan and not meeting the income limits. More people will be eligible for a Roth IRA when the new rules repealing income limits on conversions go into effect in 2010.
In anticipation of the new, expanded Roth IRA eligibility, you can maximize the amount you can convert down the road by saving more aggressively in a traditional IRA today. Then when the relaxed requirements kick in, you can convert your traditional IRA to a Roth IRA regardless of your filing status or how much you earn. A SEP or SIMPLE IRA can also be converted to a Roth.
If you've made both deductible and non-deductible IRA contributions to your traditional IRA, you may be required to pro-rate the taxable and non-taxable portions of the account under IRS rules. However, even if you have to pay tax at conversion, the new rules for Roth IRAs offer additional benefits. If you convert your traditional IRA to a Roth in 2010, you can report half the income from the conversion in 2011 and the other half in 2012 to spread out your tax obligation. Now that's something to celebrate.
There are other tax law changes that make it easier to convert funds to a Roth IRA. Beginning in 2008, you can roll over funds from a 401(k) or other employer plan distribution directly to a Roth IRA if you meet the $100,000 income limit for 2008 and 2009 and pay income tax on any taxable dollars rolled over.
If you do not own an existing IRA, it might be worth considering adding to your retirement portfolio. Consider setting up automatic contributions through your bank or workplace to make saving for your future easier and more consistent. Talk to your financial advisor to determine if a Roth conversion is right for you.
Edward Reilly CRPC, CMFC, AAMS
Chartered Retirement Planning Counselor
Advanced Financial Advisor
Ameriprise Financial Services, Inc.
333 Earle Ovington Blvd., Suite 1010 | Mitchel Field, NY 11553
Office: 516.228.0100 | Fax: 516.228.0101
edward.p.reilly@ampf.com
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Ed is a comprehensive financial planner for Ameriprise Financial. He graduated from Siena College in upstate New York with a degree in finance and international business. Ed helps his clients with retirement planning, as well as other areas, including investment planning, estate planning and college education planning. He currently works in Garden City and resides in Long Beach. Ed is extremely committed to his clients and helping his clients achieve their goals. He also enjoys playing hockey and beach volleyball in his spare time, as well as watching the Mets and Islanders.
This column is provided for informational purposes only. The information is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or your financial advisor. Neither Ameriprise Financial nor its advisors or representatives provide tax or legal advice. The views expressed may not be suitable for every situation. Consult with qualified tax and legal advisors concerning your own situation.
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