IRA’s And Retirement Planning

Posted by Doeren Mayhew

October 17, 2009

While retirement plans benefit from special tax advantages, they are also restricted by special tax regulations. For example, you are allowed a tax break if you contribute to a retirement plan and you are able to have your retirement income grow free of taxes (for a certain period of time). However, annual contributions, the total size of each contribution, and the frequency of contributions are subject to restrictions. It is important that you carefully consider your options before deciding on a retirement plan. There are generally two categories to choose from, IRAs and employer-sponsored plans.

Before you can start planning, review the retirement plans that are currently available to you. Generally, there are two categories into which all plans can be sorted: IRAs and employer-sponsored plans. IRAs are perhaps the most widely used retirement plans because they’re easy to set up and maintain. You can open up one yourself it doesn’t have to be sponsored by your employer and you can contribute as much (or as little) as you want, whenever you want, provided you don’t exceed applicable annual limits. Following are descriptions of the three main types of IRAs:

The Traditional IRA: Your IRA assets grow on a tax-deferred basis, meaning that you pay no tax until the day that you withdraw your funds.

Your eligibility to make a contribution depends on statutory limits, your earned income and your age. Your contribution is limited to the amount of earned income income from wages and self-employment income that you have for the year. It doesn’t include investment income. Those age 50 and older may be able to make additional catch-up contributions. Plus, your spouse may use your earned income to make a contribution of his or her own. However, you (and your spouse) are eligible to make contributions only if you’re under age 701/2 at the end of the year for which you’re making the contribution.

Before you decide to start with a traditional IRA, it is wise to consider your other options. These options include a Roth IRA and an employer’s 401(k) plan.

One factor that may affect your decision is the deductibility of your contribution. Your income level and other factors will determine if your contribution to a traditional IRA will be fully deductible. If neither you nor your spouse is eligible to participate in an employer-sponsored plan, your contribution is deductible no matter how much income you earn. But if you or your spouse is eligible, your tax deduction for making an IRA contribution may be reduced or completely eliminated depending on your adjusted gross income (AGI).

If you aren’t eligible to make a deductible contribution (or a Roth IRA contribution), you may wish to make a nondeductible one you’ll still enjoy the benefit of tax-deferred growth. And, when you withdraw the funds after age 591/2, only the earnings will be taxed. You can withdraw your nondeductible contribution without tax.

Roth IRA. You are able to contribute the same amount to a Roth IRA as you are able to contribute to a traditional IRA. The real difference between the two is their eligibility rules, such as the lack of an age limit with respect to contributions. This disregard for the age limit is only applicable if you meet the earned income requirement.

The total amount of your annual contribution to IRAs can never be larger than the defined limit. That being said, if you are eligible you can contribute all of your income to a traditional or all of your income to a Roth IRA. You are even allowed to split your contribution between the two different IRA?s.

The Roth IRA also differs from a traditional IRA in that you won’t be able to claim a deduction for your contributions. But all Roth IRA earnings can be withdrawn tax free after age 591/2, provided you’ve had the account for at least five years. (You can withdraw amounts up to your total contributions tax free at any time.)

If you already have a traditional IRA, then you may be interested in converting a portion, or the entire IRA, to a Roth IRA. You will need to see if this change will benefit you even after considering the additional tax implications.

The exact formula for calculating the contribution amount is very complicated. However, if you were to use 20% of your net self-employment earnings as a guess it would be a close estimate.The formula for calculating the exact contribution amount is too complex for our purposes, but a rough estimate of 20% of your net self-employment earnings is a good start.

Simplified Employee Pension SEP IRA. A SEP IRA enables self-employed entrepreneurs an avenue to make significant IRA contributions that would not be permitted under a traditional or Roth IRA plan. As far as tax purposes are concerned, SEPs are treated the same as the other types of IRAs. The main difference is that SEPs allow a much higher contribution limit than the other two.The formula for calculating the exact contribution amount is too complex for our purposes, but a rough estimate of 20% of your net self-employment earnings is a good start.

This data is distributed for informational purposes only; Doeren Mayhew is not rendering legal, accounting, or other professional advice or opinions and assumes no legal responsibility. Contact Doeren Mayhew for more information.

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IRA’s And Retirement Planning

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