You can accumulate a nice nest egg if you persistently save. Even smaller amounts add up over time, especially when the account can grow tax-deferred. You can accumulate more wealth when the IRS and New York State aren’t taking a cut of your investment earnings. An IRA can be a good retirement savings vehicle on its own or to supplement contributions to an employer retirement plan. Is it right for you?
First, you have to qualify before you can even consider it. To contribute to a traditional IRA, you have to be under age 70.5, whereas there’s no age limit to contribute to a Roth IRA. With either, you must have earned income of your own or have a spouse with enough earned income to attribute to you so you can make a contribution to a spousal IRA. Note that taxable alimony counts as earned income for this purpose.
Next, you need to be in a position to contribute. If you don’t have an emergency fund or have high-interest debt to pay down, perhaps you should focus on those priorities first to build wealth. Otherwise, yes, you should consider adding to your retirement savings. For 2015 and 2016, you can contribute the lesser of your earned income for each year or $5,500 ($6,500 if you’re at least age 50). That limit is a combined total for all contributions to traditional and Roth IRAs. Though 2015 has ended, you have until April 15 to make a 2015 IRA contribution. For that matter, you can make your 2016 contribution while you’re at it so it can start growing tax-deferred.
An IRA may be your only option if your employer doesn’t offer a retirement plan. Even if you do participate in an employer retirement plan, you can still contribute to an IRA whether you get an income tax deduction or not. If you are an active participant in a retirement plan, a married person’s traditional IRA deduction begins to phase out at an AGI of $98,000. If you don’t participate in a retirement plan but your spouse does, your IRA deduction begins to phase out at an AGI of $184,000 if you file jointly. Beyond that, your contribution would be a nondeductible, after-tax contribution. That’s OK. This creates basis in your IRA for later distributions to come out partially tax-free. In the meantime, the account can grow tax-deferred.
Contributions to a Roth IRA are not deductible. They are made with after-tax dollars. But the advantage is that even the earnings can come out tax-free when taking qualified withdrawals. Additionally, there is more flexibility with Roth IRAs. Should there be some emergency, you can always take out your contributions anytime tax-free and penalty-free. Also, there’s no required minimum distributions come age 70.5. When given the choice of contributing $5,500 to a traditional IRA or to a Roth IRA, the Roth IRA contribution will be more valuable in retirement because it can come out tax-free then. It becomes a bit of a forced savings strategy by foregoing a tax deduction now when you can better afford it in order to build something of greater after-tax value in retirement, when you need it most. We like Roth IRAs so much that we’d even say to prioritize making that contribution over an employer retirement plan contribution beyond any company match threshold. You should always contribute enough to a company retirement plan to maximize any employer match. Beyond that, we favor the Roth IRA up to its limits and the employer plan for any additional. That being said, not everyone can contribute to a Roth IRA. There are AGI limitations. Eligibility to contribute to a Roth IRA begins to phase out at an AGI of $117,000 for a single filer and $184,000 for a married-filing-joint filer.
If you’re over those AGI limits and still wish to contribute to a Roth IRA, there is currently another strategy to get the money into a Roth IRA. If you have no other pre-tax IRA balances from prior deductible contributions or rollovers from employer retirement plans, or a SEP IRA or SIMPLE IRA account, you could make a nondeductible 2015 contribution to a traditional IRA. Immediately thereafter, you could convert that balance to a Roth IRA. There are no AGI limits for a conversion. There would be no taxable effect if you hold the traditional IRA contribution in a money market fund so it doesn’t appreciate before conversion. Then you can invest it however you wish once it has been converted to a Roth IRA. Granted, the government is looking to close this back-door Roth IRA loophole, but for the time being, it is still viable.
IRAs can be very attractive to those who don’t have an employer plan to contribute to, and for those who have excess funds they’d like to grow tax-deferred. Don’t miss the April 15 deadline to make a 2015 traditional or Roth IRA contribution!
Cindi Turoski is a managing member of Bonadio Wealth Advisors based out of our Albany, NY office.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.