IRA’s & Your Personal Finance

Learn how Individual Retirement Accounts can help you achieve your future goals in an efficient manner

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If you are considering opening and IRA to help fund your retirement years—or for educational or other purposes—you must be aware that the contribution limit is $5,000—or $6,000 if you are age 50 or older.

If you were to invest "more than" the annual limits listed above it would be considered an “excess contribution” and the IRS could impose harsh penalties.

Single Limits

In 2011 the income cutoffs for a traditional IRA where you can get the full deduction is $56,000 and partial deduction is $65,999 if you are single.

In 2011 the income cutoffs for a ROTH IRA where you can get the full contribution is $107,000 and partial contribution is $122,000 if you are single.

Married Limits

In 2011 the income cutoffs for a traditional IRA where you can get the full deduction is $90,000 and partial deduction is $109,999 if you are married.

In 2011 the income cutoffs for a ROTH IRA where you can get the full contribtion is $169,000 and partial contribution is $179,000 if you are married.

Keep in mind that the above figures represent the "income cutoff" that is based on your AGI or Adjusted Gross Income—not Total Income!

The annual contribution limit is $5,000 if you are single and have earned income ($6,000 if you are over age 50).

The annual contribution limit is $10,000 if you are married and have earned income ($12,000 if you are both over age 50).

If your earned income is less than the contribution limit—your contribution is limited—to your earned income!

Deadline to Contribute

Also keep in mind that you have until the tax deadline (April 17) to fund your IRA for 2011—and be sure that you understand that with a traditional IRA–your contributions are in pre-tax dollars (deducted on your tax return)—and your withdrawals are taxable.

You can make 2011 contributions up until the April 17th deadline and you can make 2012 contributions up until the 2012 tax filing deadline of April 15, 2013.

With a ROTH you pay your taxes upfront, however you or those who inherit your IRA—will owe no taxes on withdrawals. Depending on your tax bracket—the ROTH is often the best choice in the long run—for many.

Conversion from Traditional to ROTH

You can convert from a traditional to a ROTH regardless of your income. Be aware that you might have a large tax bite!

If you do not yet have an IRA—you can set up one at any time.

You can also convert to a ROTH at any time—just be aware of your taxes that you will have to pay—prior to doing the conversion.

Converting is particularly important if you anticipate being in a higher tax bracket in your retirement years. With 2012 tax rates scheduled to end at the end of 2012—you would face a maximum tax rate of 35%.

Depending on your age and income streams—it can often be difficult to determine whether you will be in a higher or lower tax bracket during your retirement years.

ROTH IRA & College Planning

ROTH accounts could also work for you in college planning—and as an added bonus if your child has enough to go to college with other means—such as your current income, financial aid, scholarships etcetera—you could avoid using the ROTH for your child's education—and continue building up the account for (your and your spouse's) retirement years.

Withdrawals of your "contributions" would be tax free. There would be no 10% early-withdrawal penalty on earnings if you use the money for educational expenses.

If you were under age 59 1/2 and held the account for less than five years you would owe tax on the "earnings" at your ordinary income tax rate plus a 10% penalty for early withdrawal unless an exception was applicable.

If you plan on using a ROTH make sure you have a well thought out strategy.

Be sure you have your retirement goals in place and a strategy to get to the "number" that you need—dollar wise—to live at your pre-retirement levels.

For example, if your "number" was $500,000 and you were age 65 you would be able to withdraw $20,000 per year for approximately 30 years assuming a modest rate of return.

You would also factor in your Social Security and any other income.

If tapping into your ROTH for your child's educational expenses would prevent you from getting to your "number"—you would have to increase the ROTH contributions—or other Retirement Account contributions—or pursue another educational funding strategy.

If you plan on using a ROTH account for educational funding be sure to start well in advance. ROTH accounts have a $5,000 per year limit—$6,000 if you are over age 50.

If you are married your spouse can also contribute $5,000, or $6,000 per year if age 50 or higher.

Always Remember—To Contribute to "Any" IRA You Must Have Earned Income

Keep in mind that in order to contribute to a ROTH you must have earned income (employer or self-employed) and there are income limits of $122,000 Modified Adjusted Gross Income for Single and $179,000 for Married Filing Jointly.

If you contribute $5,000 annually from the time your child is born you would have $90,000 in "contributions" alone. Assuming you had a modest annual return, your total account value could be over $200,000 by the time your child attended college.

If your spouse also contributed the total "contributions" would be $180,000 and the account value could be over $400,000 by the time your child attended college.

IRA’s & Alternative Investments

If you open a self-directed IRA with a custodian willing to deal with alternative assets—you could invest in real estate, gold bullion, tax liens, race horses and other—more speculative investments. You cannot invest in art or life insurance.

It is not always wise to invest in more speculative IRA holdings—even though you are legally allowed to do so. When dealing with IRA’s that offer more exotic types of investments—you can often run into those who are con-artists and very smooth in their articulation of what they are offering—and the returns you could possibly get.

Due to the large number of baby-boomers converting their 401k’s and other retirement accounts to an IRA—con artists feel they have a ripe and lucrative market.

You must be very careful if you are even considering any out-of-the-ordinary type of investments.

Also, realize that there are even more inherent risks when investing in non-traditional ways.

You will have market risk if you invest in gold or real estate. You must also use funds that are inside of the IRA—for renovations and upgrades that you want to do to real estate you own inside of an IRA! You will have the risk of horses getting sick or dying—if you invest in racehorses…and so on.

If you are determined to invest in alternative—out-of-the-ordinary type of investments—consider doing so (inside of an IRA) with a mutual fund that invests in a broad range of investments and has a five to 10 year track record of success.

If your goal is to invest in real estate—consider a mutual fund that invests in a broad range of properties.

By doing so you will reduce your risk from being conned—and reduce other risks that were mentioned above.

Final Thoughts on IRA’s

The bottom line is that IRA’s—both ROTH and Traditional—are an important tool to help you reach your retirement and other goals and should be given strong consideration by you—if your goal is to improve your living conditions for yourself and your family—to a high level.

With a traditional IRA—you get a deduction up front on your tax return and you pay taxes on your distributions at "ordinary income" tax rates—whereas, with a ROTH you get no deduction up front, however all "qualified" distributions are tax free.

A Properly Funded IRA Can Enhance Your Future Living Conditions

If you have addressed your finances in a comprehensive manner and are in financial position to do so—IRA’s should be a part of your financial strategy to help you and your family attain the future goals that you desire.

Be sure you use realistic projections and you invest consistently using a portfolio that fits your investment style. You can also consider target-date funds inside of an IRA.

By starting early in your “life stage” you can set yourself and your family up for real success—in a relatively painless manner.

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The above article was written by Thomas (TJ) UnderwoodThomas (TJ) Underwood is a former fee-only financial planner, a former top producing loan processor and is currently a licensed real estate broker in the state of Georgia. 

He is the writer behind The Real Estate & Finance 360 Degrees Series of Books that include The Wealth Increaser, Home Buyer 411 The Smart Guide to Buying Your Home, Home Seller 411 The Smart Guide to Selling Your Home, and  Managing & Improving Your Credit & Finances for this MILLENNIUM.

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He is the creator of where he regularly blogs about helping consumers improve their credit, finance and real estate pursuits in an intelligent, consistent and proactive manner. 

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