Everyone ought to have an IRA

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In his classic Broadway musical comedy, A Funny Thing Happened on the Way to the Forum,. Steve Sondheim tells us that “Everybody ought to have a maid”. I agree. 

I also believe that everybody ought to have an IRA. 

No matter their earned income, age, level of income, wealth, or coverage under an employer plan, everyone should have an IRA as a form of secured savings. This is because of the multiple benefits of an IRA account. These benefits include the tax deferred (or tax-free) accumulation of income, the possible tax deduction it can provide and the fact that IRAs are, in most cases, protected from general creditors to whom you may owe outstanding debts. This also applies during bankruptcy procedures. 

You should, of course, begin by taking as much advantage as possible of your employer’s 401(k), 403(b), 457, or other retirement plan. Hopefully, you’ll be able to obtain the maximum annual allowable contribution on that plan. 

There are two types of IRAs: The “traditional” IRA and the Roth IRA. If you can get a Roth IRA, you should use it as your current savings account. 

$5,500 is the maximum amount that you can contribute to a Roth IRA, a traditional IRA or a combination of the two in 2018. You can contribute an additional $1,000 If you are 50 or older. A non-working spouse can open an IRA and contribute an amount up to the maximum as long as the other spouse has earned income. The combined contributions of working and non-working spouses are limited to the working spouse’s earned income. 

Contributions to a Roth IRA are never deductible on your federal or state income tax returns. However, earnings on money held in a Roth IRA account can eventually become tax-free for you and your beneficiaries. 

Here is what you need to know about a Roth IRA: 

  • You can contribute to a Roth IRA at any age as long as you have earned income from a job or are self-employed. You do not have to stop making contributions at age 70½ if you still have earned income. 
  • The amount of your allowable contribution to a Roth IRA is phased out and eventually eliminated based on your adjusted gross income (AGI). The AGI phase-out range for taxpayers making contributions to a Roth IRA in 2018 is: 

  1. $120,000 – $135,000 = single and head of household 
  2. $189,000 – $199,000 = married filing joint and qualifying widow(er) 
  3. $0 – $10,000 = married filing separately 

  • You can withdraw your contributions at any time without taxes or penalty. All withdrawals are considered to be from contributions first. 
  • You must hold the Roth account for at least five years and be at least 59½ before you can withdraw earnings tax- and penalty-free. This five-year period begins on the day you make your first Roth contribution. 
  • You never have to take any withdrawals from a Roth IRA in your lifetime. There are no annual required minimum distributions beginning at age 70½. 

As long as you never touch the accumulated earnings from your Roth IRA investment and withdraw only your contributions, you can take money from this account at any time without any tax penalty. Additionally, your accumulated earnings will grow to a nice retirement nest egg or legacy for your beneficiaries if invested wisely. 

Let’s say that you have contributed $10,000 to a Roth IRA, which has accumulated earnings of $2,000. You need $5,000 or as much as $10,000 to pay for an extraordinary expense, such as a medical bill. You can take that money from your Roth IRA account without any tax consequences. 

Contributions to a “traditional” IRA may provide a current tax deduction. If all of your traditional IRA contributions have been fully deductible, then all subsequent withdrawals are fully taxable. The amount that you can deduct may be phased out based on your “modified” adjusted gross income (MAGI) if you are an active participant in an employer-sponsored retirement plan like a 401(k), a 403(b) or an SEP. 

Your “modified” AGI for purposes of the deduction phase-out begins with “regular” AGI and adds back the: 

  • foreign income and housing exclusions and deduction 
  • savings bond interest exclusion for higher education costs 
  • adoption assistance benefits exclusion 
  • deduction for student loan interest

In 2018, the amount of a contribution to a traditional IRA that can be claimed as a deduction on the tax return of an active participant in an employer retirement plan is phased out if adjusted gross income (AGI) is: 

  1. • $ 63,000 – $73,000 for single and head of household 
  2. • $101,000 – $121,000 for married filing joint and qualifying widow(er) 
  3. • $0 – $10,000 for married filing separately 

The deduction on a joint return for a spouse who is not an active participant in an employer plan, but who is married to a participant, phases out at AGI of $189,000 to $199,000. 

You can still contribute the maximum amount to an IRA account even if your deduction is limited or totally phased out. Part of the contribution will be “non-deductible.” Non-deductible contributions create a “basis” in your IRA investments and part of your future withdrawals will be partially tax free as a “return of basis.” 

You can also use IRAs to save for education and expenses like medical bills and buying a home. Exclusions to the premature withdrawal penalty exist for these types of expenses. 

As far as reporting the activity within an IRA account – as I explained in a 2009 post on my blog, The Wandering Tax Pro – “What happens in an IRA stays in the IRA.” 

Younger employees who are just starting out should definitely opt for a Roth IRA. Here are two suggestions for funding IRA contributions if you are starting your first full-time job: 

(1) If you have any leftover cash from graduation gifts, open a Roth IRA account and use that money to fund your contribution. 

(2) Take an empty coffee can or other form of piggy bank and put it in your bedroom. Beginning the first week of January, put $10, $20, or $50 in this “bank” each week. On January 2 of the following year, take the money that has accumulated in this “bank” and contribute it to your Roth IRA for that tax year. Continue this practice over subsequent years. 

Here is another good idea: If your child has a summer or after-school job, you should consider opening a Roth IRA account for them. Money that you give to your child for doing chores doesn’t count, but earnings from babysitting or mowing lawns might. 

You can contribute 100% of your child’s earnings to the account up to the $5,500 maximum. If your child earns $2,400 for the summer, you can contribute $2,400 to a Roth IRA for them. If they earn $6,000, you can contribute $5,500. 

There is nothing in the tax code that says that the money deposited in an IRA for your child has to come from their funds. You can use your own money to fund the IRA contribution and let your child keep their earnings. 

You can use a Roth IRA to encourage your children to work or to save. If your son earns $5,000 from a part-time job, open a Roth IRA for him. If your daughter agrees to put $2,500 of her salary from a summer job in a Roth, match it and put in another $2,500 (assuming her total earnings for the year are at least $5,000). 

If you put the maximum amount into a Roth account each year for your 16-year-old from 2018 to 2023 (when they turn 21), and no other contributions are ever made, that account could grow to a truly tidy sum (six figures) by the time they turn 65. There’s only one potential problem with opening an IRA account for a child: Once they reach the “age of majority,” usually 18, they will have full access to all the funds and could take the money and run if they so elected. 

One last thing: The earlier in the year you contribute to your or your children’s Roth IRA, the more money you will accumulate tax-free when you retire. So, if it’s not already done, make your 2018 Roth IRA contribution today and make your 2019 contribution on January 2nd of 2019. 

If you have questions about how the Act will affect your specific situation, I suggest consulting a tax professional.

Robert D Flach has been preparing 1040s for individuals in all walks of life since 1972 and has been writing the popular tax blog “The Wandering Tax Pro” since 2001.

This article originally appeared on The Wandering Tax Pro and was syndicated by MediaFeed.org.

Featured Image Credit: depositphotos.com.

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