In addition to 401(k)s
and similar retirement plans that are sponsored by employers, individual retirement accounts (IRAs
) offer tax advantages
too great to pass up.
The plain-vanilla type of IRA is a regular IRA
. Regular IRAs are also called traditional IRAs. Roth IRAs
were introduced in 1998. For 2008, you are allowed to contribute up to $5,000 to your IRA. If you have more than one account, you may contribute to all of them, as long as the total contributed is not greater than the yearly limit.
As a result of the Economic Growth and Tax Relief Reconciliation Act of 2001, you can make larger contributions
to a regular or Roth IRA beginning in 2003. A catch-up provision
allows workers who turn age 50 to make even larger contributions.
The following table shows new individual contribution limits for regular (and Roth) IRAs. Beginning in 2009, limits are are indexed
to inflation in increments of $500:
Yearly individual contribution limits (2004-2008):
|Year||Yearly limit||Additional contributions|
(age 50 or older)
Contributions to regular IRAs are tax-deductible
, subject to income limits
and your (or a spouse's) participation in an employer-sponsored plan. The earnings on an IRA grow tax-deferred
, which means you don't owe income taxes until you begin to take distributions
from the account.
You can begin to take penalty-free distributions from a regular (or Roth) IRA in the year after you reach age 59-1/2. In most cases, you must pay an early-withdrawal penalty
if you take a distribution sooner. Regular IRAs require that you begin to take distributions when you reach age 70-1/2. The amount you are required to take each year is called your required minimum distribution (RMD
). To calculate your required minimum distribution,
see Appendix C of IRS Pub. 590
: "Individual Retirement Arrangements."
Nondeductible contributions to regular IRAs
If you earn too much income, or already participate in a 401(k) or similar retirement plan, your tax-deductible contributions to a regular IRA are gradually phased out
. This means that some of your contributions to a regular IRA cannot be deducted from your income. The contributions that are not tax-deductible are called nondeductible
Here are the income limits at which your tax-deductible contributions phase out:
Single filers that participate in a plan.
If your modified adjusted gross income (MAGI
) is more than $53,000 and less than $63,000 in 2008, some of your contribution is nondeductible
. Above $63,000, your entire contribution is nondeductible.
Married persons filing a joint return and you (but not your spouse) participate in a plan. If modified adjusted gross income is more than $85,000 and less than $105,000 in 2008, some of your contribution is nondeductible. Above $105,000, your entire contribution is nondeductible.
Married persons with neither spouse participating in a plan. No income limits exist. For 2008, you can make a fully tax-deductible contribution of up to $5,000 to each spouse's IRA. The catch-up provision allows persons age 50 or older to contribute up to $6,000.
To help you calculate a nondeductible contribution, see the worksheet for a reduced IRA deduction in IRS Pub. 590
. You will also have to complete IRS Form 8606
to ensure that you don't pay income taxes later on the amount of contributions you've already paid taxes on.
You can contribute up to $5,000 to a Roth IRA
for 2008. The same catch-up provision allows persons age 50 or older to contribute up to $6,000 to a Roth IRA or combination of accounts.
A big difference in regular IRAs and Roth IRAs is that your contributions to a Roth IRA are not tax-deductible. Instead, your contributions are made after paying income taxes. This disadvantage would seem to favor regular IRAs. However, if you keep a Roth IRA for at least five years and have reached age 59-1/2, become disabled, die or incur allowable expenses related to a first-time home purchase, the entire amount is exempt from income tax and IRS penalties.
Also, Roth IRAs do not have required minimum distributions, which gives you more flexibility in planning your estate
. If you wish, you can leave the entire amount of a Roth IRA to your beneficiaries
At higher incomes, allowable contributions to a Roth IRA phase out altogether:
Single filers. If your modified adjusted gross income for 2008 is more than $101,000 and less than $116,000, you can make a partial contribution. At incomes above $116,000, you cannot contribute.
Married persons filing a joint return. If modified adjusted gross income for 2008 is more than $159,000 and less than $169,000, you can make a partial contribution. At incomes above $169,000, you cannot contribute.
To calculate a partial contribution:
Calculate your modified adjusted gross income. . Example 1 assumes you are 45 years old, report a MAGI of $111,000 for 2008, and file a single return. Example 2 assumes you and your spouse are both age 50, report a combined MAGI of $164,000, and file a joint return.
Subtract lower range of income phase-outs. For single taxpayers, the lower range where your allowable contribution begins to phase out is $101,000. For married taxpayers filing a joint return, the lower range is $159,000. For Example 1, subtract $101,000 from $111,000 to obtain $10,000. For Example 2, subtract $159,000 from $164,000 to obtain $5,000. (See IRS Pub. 590 for other circumstances.)
Divide amount by the appropriate divisor.. For single taxpayers, the divisor is $15,000. For married taxpayers filing a joint return, the divisor is $10,000. For Example 1, $10,000 divided by $15,000 is equal to 0.667, rounded to three decimal places. For Example 2, $5,000 divided by $10,000 is equal to 0.50.
Multiply the result in step 3 by $5,000 for a 2008 contribution ($6,000 if age 50 or older). Be sure to subtract any contributions to a regular IRA for the respective year. For Example 1, 0.667 multiplied by $5,000 is equal to $3,333. For Example 2, 0.50 multiplied by $6,000 is $3,000.
Subtract the result in step 4 by the maximum allowable contribution and round up to the nearest $10. For Example 1, $3,333 subtracted from $5,000 is equal to $1,667, and rounded up to the nearest $10 is $1,670. For Example 2, $3,000 subtracted from $6,000 is equal to $3,000. Since this amount is already rounded, it is your allowable contribution for 2008.
The following tables show allowable partial contributions to a Roth IRA for 2008:
|45-year old investor(s)||2008|
|Example 1: Single (MAGI of $111,000)||$1,670|
|Example 2: Married filing jointly (MAGI of $164,000)||$2,500|
|50-year old investor(s)||2008|
|Example 1: Single (MAGI of $111,000)||$2,000|
|Example 2: Married filing jointly (MAGI of $161,000)||$3,000|
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.