IRAs

Well, its startin' again. It has been awhile since this newsletter has gone out. So many things have been happening that it was put on the back burner. Many new names have been added to the list so this will probably come as a surprise to many. Its my hope that the newcomers will get as much out of this newsletter as many of you ole' timers have graciously told me.

Its that time of the year again - tax time - so its a good time to talk about IRAs. "Everybody knows about IRAs," one may say. Well, you would think so. I come across many people who think an IRA is something that you go to the bank and get. This narrow perception only touches the tip of the iceberg and severely limits those individuals in their retirement planning.

IRA means individual retirement account or individual retirement annuity. When one creates an IRA, a "shell account" is opened. When money is contributed to that account, it is considered funded, and the individual deducts the contribution on their tax return. Pretty simple, huh?

Contrary to popular opinion, the money used to fund an IRA can be invested in numerous vehicles, with few limitations. Practically, almost any investment available in the marketplace is available to fund an IRA; e.g., stocks, bonds, mutual funds, annuities, treasury securities, limited partnerships (oil, gas, and r.e. mortgages), savings and CDs, unit investment trusts, gold coins, etc. Funding mistakes are very common. When making a funding choice, one must consider the time element. IRAs are considered retirement vehicles, therefore, any investment that is oriented toward short time periods are bad funding vehicles; e.g., savings accounts, money market accounts, certificates of deposit, treasury bills, etc. Any IRA monies spent before age 59 1/2 will be subject to penalty, therefore, the minimum time frame has been established. The maximum time frame depends upon other income sources. Typically, one will draw income from pensions and social security first, thus allowing more time for an IRA to grow. Many retirees don't have to draw out any IRA monies until the mandated distribution rules kick in at age 70 1/2. These rules and required distribution amounts are set forth in IRS Publication 590. Since contributions and distributions can last a lifetime, doesn't it make sense to fund the IRA with something that maintains, or better yet, exceeds, purchasing power?

Another overlooked factor is the phaseout rules. These rules only apply to those who are participating in an employer-provided retirement plan. If one spouse participates and the other does not, it affects both. The rule basically says that if one's adjusted gross income (AGI), excluding IRA, exceeds $50,000 ($35,000 for singles), then there is no IRA deduction allowed. On the other hand, if AGI is $40,000 ($25,000 for singles) or less, then a full IRA deduction is allowed. The range $40,000-$50,000 is the phaseout range, whereby only partial deductions are allowed. For example, let's assume a married couple has an AGI of $42,500. Their income has exceeded the minimum range amount by $2,500 or 25%. This leaves 75%. Each spouse could deduct $1,500 (2000x.75) into an IRA, assuming both worked.

If you will notice, I used the word deduct in the previous paragraph. The phaseout rules only determine what one may deduct. A full IRA contribution is always allowed, but because of AGI, it may not all be deductible. The non-deductible portion is called, you got it, a non-deductible IRA. Even though these monies may be commingled, one must maintain separate records. Once taken out, the tax consequences are different and thus the taxpayer is responsible for future justification of any tax underpayment. PLANNING TIP: don't make non-deductible IRA contributions. Even though the earnings are tax-deferred, the logistics are not worth it. One can still get the same tax-deferred benefits by investing in annuities plus the added benefit of no contribution limitations. A "have your cake and eat it too" suggestion.

Another planning mistake is not integrating other tax-qualified plans to maximize IRA deductibility. There are other contributory plans that reduce one's reportable income. If these plans reduce the income shown on a W-2, then it also reduces AGI. Get the picture? When these other plans are available, the IRA should play second fiddle. Corporations sometimes offer a 401(k) plan. Contributions have the same effect as an IRA except the limitations are higher and the deductions are made right out of the paycheck - convenience is the byword. Educational and not-for-profit institutions have a similar plan called a 403(b). Both of these plans will allow an individual to build up a hefty retirement nest-egg. PLANNING TIP: Maximize the pretax contributions in these plans before any consideration is given to an IRA. Also, make sure you check out all the investment options and consult professional advice. Funding choices are just as critical as in an IRA. Right funding choices can amount to tens, and sometimes, hundreds, of thousands of dollars difference. Next, IRS Section 125 plans, or more popularly known as Cafeteria Plans, offer many benefits on a pretax basis. Take full benefit of this plan, if offered, before considering an IRA.

Lastly, it pays to postpone taxation. Assuming one is in a 28% tax bracket, there will be $280 saved for every $1,000 invested in an IRA or one of the other tax-qualified plans mentioned. Yeah, taxes eventually have to be paid. Over 5 years, one has postponed paying $1,400 (280x5) in taxes. Conversely, assuming an 8% growth rate, the IRA account value would be $8,827. Taxes owed would be $2,472. After subtracting the taxes (2472) and $5,000 invested, the taxpayer still profited $1,355. Magnify this by full IRA and other tax-qualified contributions over one's lifetime. Get the drift?

Retirement is a modern phenomena. I don't remember anywhere in scripture where someone retired. What I do find is Biblical characters using God's provision in ways honoring to Him. There is nothing wrong or unholy with one accumulating wealth, assuming its for the correct reasons. God owns everything (Psalms 24:1). Everything we accumulate is to be used for many purposes; e.g., providing for our family (I Timothy 5:8), help those in need (I John 3:17), and to support those who proclaim the gospel (I Corinthians 9:14). On the flip side of the coin, one should continually examine the reasons for accumulating an enormous retirement nest-egg. There is, however, something seriously wrong with accumulating for selfish reasons. I am constantly reminded in II Corinthians 8 that wealth is for the purpose of providing for the needs of all. For the disobedient and selfish, He taketh away, as experienced by the covetous man in Luke 12:13©21.