By John Kim
Whether you choose a traditional or Roth IRA, the tax deferred compounding of your IRA funds can help you save more for retirement, on an after-tax basis, than the same amount of funds in a taxable savings account, as the chart below illustrates. Assuming a maximum IRA contribution — without catch-up — is made each year beginning in 2002, an 8 percent rate of return, and an ordinary income tax bracket of 25 percent, the comparison is striking.
THE IRA ADVANTAGE This is an IRA that is deductible under certain circumstances, and that permits penalty-free withdrawals if you are over 59 years old — at which time your money is subject to ordinary income tax. The traditional IRA also offers favorable tax treatment on withdrawals for certain financial goals, such as homeownership and higher education.
Roth IRA is a non-deductible IRA that permits tax-and penalty-free withdrawals of contributions and earnings — if the account is held for five years and you are over age 59. Contributions to a Roth IRA can be withdrawn at any time tax-and penalty-free.
DO YOU QUALIFY FOR AN IRA?
One of the most effective ways to build funds to help you meet your financial goals is through an Individual Retirement Account, also known as an IRA. Have you considered the benefits of opening an IRA? A maximum annual contribution of $3,000 has the potential to grow substantially over time, as all contributions and earnings compound in the account, tax-deferred. If you haven’t already done so, there’s still time to open and fund an IRA for 2002. You can make a maximum annual contribution of $3,000 to your IRA, and an additional $500 if you are 50 years old or older. Therefore, you could potentially contribute up to $7,000 to an IRA this year.
When establishing an IRA, factors to consider include your age, adjusted gross income, current and projected tax brackets, and you and/or your spouse’s participation in an employer sponsored retirement plan.
An individual who has earned income or whose spouse has earned income may contribute to a traditional IRA as long as the IRA account holder has not reached age 70 — by the end of the contribution year. Contributions to a Roth IRA may continue beyond age 70. For 2003, the annual maximum contribution to an IRA is $3,000, or 100 percent of earned income, whichever is less. The annual catch-up contribution in 2002 and 2003 is $500 for those 50 years old or older, making a possible total annual contribution of $3,500.
No matter how old you are, if your adjusted income (AGI) is under $95,000 (single) or under $150,000 (joint), you may open and make a full contribution to a Roth IRA. Partial contributions are permitted if you are single and your AGI is between $95,000 and $110,000 (if married, between $150,000 and $160,000). There are no AGI limits for contributions to a traditional IRA.
Roth IRA contributions are nonde-ductible under all circumstances. Deductibility of traditional IRA contributions from current gross income depends on your AGI and whether or not you and/or your spouse participate in an employer sponsored retirement plan. To determine your eligibility for a deduction on your traditional IRA contribution, contact your financial or tax advisor.
How do you decide which IRA is appropriate for you? Speak with your financial and/or tax advisor to learn more about the advantages of each account and to determine which type of IRA best fits your particular retirement goals and financial circumstances. They can provide you with a comparison between a Roth and a traditional IRA, which could help you make an informed decision suited to you particular retirement goals. (John Kim is a financial consultant with Smith Barney in Beverly Hills. Visit his Web site at www.fc.smithbarney.com/jkim. Smith Barney does not provide tax and/or legal advice. Consult your tax and or legal advisors for such advice. Smith Barney is a division and service mark of Citigroup Global Markets Inc. Member SIPC. This article is based, in whole or in part, on information provided by the sales and marketing communications department of Smith Barney).
Originally published in the Santa Monica Daily Press print edition on December 11, 2003. Read the original PDF.