Advice IQ: Making the best use of your IRA
An individual retirement account is a powerful tool to save for retirement outside of an employer plan. If you have an IRA, read on for tips that help you make the most out of it.
This year marks the 40th anniversary of the IRA, so let's run down the history for a moment. In 1974, via the Employee Retirement Income Security Act, Congress made this retirement plan available for workers whose employers could not provide them with a traditional type of retirement plan.
In 1981, Congress made the IRA generally available to all taxpayers. As a part of the Taxpayer Relief Act of 1997, we saw the launch of the Roth IRA. Unlike a traditional IRA, contributions to a Roth IRA are not tax-deductible, but earnings (and contributions) are tax-free upon distribution. This year, the Treasury introduced the Roth-IRA-like myRA that only invests in government bonds.
According to the Employee Benefit Research Institute, as of the most recent data available (2012), 19.9 million Americans had at least one IRA account. The total amount of money in those accounts was approximately $2.09 trillion. These accounts represent a powerful option for average investors to meet their retirement goals, so it is important to understand how to make the best use of them, traditional or Roth.
Make contributions as early in the year as you can. A year's worth of tax-advantaged compounding on each annual contribution over the course of your pre-retirement life betters your results dramatically. For example, a 35-year-old who makes the maximum annual IRA contribution every Jan. 1 ($5,500, with an extra $1,000 starting at age 50) could accumulate $582,787 after 30 years, assuming a market average growth of 7%. If that same person waits until Dec. 31 to make each annual contribution, the total is $535,434, almost $47,000 less.
Take advantage of the time extension. Even if you're unable to make the full contribution early in the year, you have until April 15 of the following year to catch up. Many taxpayers don't realize that there is an extension for previous years' contributions. You can, for example, wait until next April 15 to make contributions for the 2014 tax year.
Make contributions even though they are not deductible. The Internal Revenue Service sets income limits for IRA contributions to be tax deductible. For married couples filing jointly, for example, if your adjusted gross income, or AGI, is higher than $116,000, you are not be able to make deductible contributions. But this doesn't make an IRA any less valuable. The tax-deferral feature is still there, even if you are unable to deduct the contributions. And Roth IRA contributions are never deductible, but the back-end non-taxable distribution feature makes up for that.
Double your deduction with a non-working spouse's IRA. Single-income couples can contribute to an IRA for both spouses. Even if only one person has an income for the year, as long as the income is within the limits, you can contribute to IRAs for two people.
As valuable as the tax-deferral feature is for both the traditional and the Roth IRA, you are literally throwing money away if you don't take advantage of these accounts. Use these tips to optimize your ability to save taxes and secure a comfortable retirement.
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Jim Blankenship, CFP, is an independent financial planner at Blankenship Financial Planning in New Berlin, Ill., and a member of theAdviceIQ Financial Advisors Network, which is a USA TODAY content partner offering financial news and commentary. Its content is produced independently of USA TODAY.