You’re running out of time! If you’re considering making a contribution to a traditional or Roth IRA, you have until April 15 to do so for 2013. IRAs are a great way to save money for retirement and potentially receive a tax deduction at the same time.
Only 15% of households saved in any type of IRA in 2012, according to the Investment Company Institute. An IRA can play a complementary role to employer-sponsored plans, such as a 401K, and is increasingly important in saving for retirement. It allows your money to grow tax-deferred until you begin taking withdrawals.
Which IRA is right for you? Well, that depends on several factors – let’s take a look.
The benefits of a traditional IRA far outweigh the restrictions. There are no income restrictions with a traditional IRA. You can contribute as long as you’re younger than 70 ½ and have earned-income through an employer, self-employment income or commissions.
IRA contribution limits for 2013/2014:
- If you’re younger than age 50, you can contribute a maximum of $5,500.
- If you’re age 50 and older, you can contribute a maximum of $6,500.
Contributions to a traditional IRA may also be tax-deductible, depending on your income and whether you have a retirement plan through your employer. High earners who are covered by a retirement plan at work may not qualify for a tax deduction.
For the 2013 tax year, your IRA contributions won’t be deductible if you are a single filer with modified adjusted gross income (MAGI) of $69,000 or more ($115,000 for married couples filing jointly). If you’re married filing jointly with a spouse covered by a plan but you’re not, you can also make deductible IRA contributions if the MAGI is below $188,000.
When it comes to building a nest egg, the Roth IRA is gaining in popularity. The main difference between a Traditional IRA and a Roth IRA is when you pay the taxes. With a Roth IRA, taxes are paid up front as contributions are made with after-tax money. That means you don’t owe Uncle Sam a dime when you begin taking withdrawals in retirement, as long as you have held money in the account for at least five years and are at least age 59 ½.
“Roth IRAs offer valuable diversification from a tax perspective. You now have available a stash of money that you will be able to access in retirement free of taxes, that is not subject to Required Minimum Distributions at age 70-1/2, and that can be passed on tax-free to your heirs,” says Greg McBride, chief financial analyst for Bankrate.com.
While contribution limits for Roth IRAs are identical to traditional IRAs, income limits prohibit high earners from contributing directly to a Roth IRA.
For 2013, a married couple who files taxes jointly and earns more than $188,000 per year cannot contribute to a Roth, and single filers earning more than $127,000 are also prohibited. In 2014, the income caps are $191,000 for married couples filing jointly and $129,000 for single filers.
Roth IRA Conversion
Despite income limits, affluent Americans are showing a growing preference for paying taxes on their retirement savings sooner rather than later, according to data released by the IRS in January 2014. Conversions from tax-deferred IRAs to Roth IRAs increased 800 percent in 2010, to $64.8 billion. The explosive growth was due to the 2010 changes when the $100,000 income limit on eligibility to convert was eliminated.
A Roth conversion is attractive if you expect your future tax rate to be higher than your current rate. And if your earnings are high enough to prevent you from contributing directly to a Roth IRA, you can use a Roth conversion as a back door entry into future tax-free income in retirement
When converting to a Roth IRA, there are three important factors you should consider:
Time: Generally, it makes less sense for older individuals to convert from a traditional IRA to a Roth. You must hold the money in a Roth for a minimum of 5 years, and be at least age 59 ½ for the earnings to be withdrawn tax free.
Taxes: When you convert a traditional IRA to a Roth account, you’ll owe taxes on the original account’s earnings and pretax contributions. Any deductible contributions and all growth in the account will be treated as taxable income when converted. This tax bill is at your ordinary income tax rate.
Cost: The cost to convert depends on several factors – how much you convert, other taxable income you have, and your top marginal tax rate. You must make sure you have, and set aside, the cash to pay this tax bill when it comes due. Otherwise, you put a dent in your account’s compounding power.
Don’t Wait Until the Deadline
If you wait until the April 15 deadline to make a prior-year contribution to your IRA, you’re missing out on substantial gains.
“Waiting until the April 15 deadline to make your IRA contribution is better than not making the contribution at all, but you’ve missed out on the potential for 15-1/2 months’ worth of gains by waiting until the end of the contribution window rather than making that contribution at the beginning of the window,” says McBride.
Whether you choose a Traditional or Roth IRA, the tax benefits provide increased value to your retirement nest egg. With Ally Bank IRAs, you get great rates, there’s no minimum deposit to open, and no monthly maintenance fees. In addition, you get the best rate we offer on the day you open or fund your IRA, when you fund within 90 days. And your deposits are insured by the FDIC up to the maximum allowed by law.
Do you contribute to an IRA? Which retirement plan do you feel best fits your financial goals and situation?