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Supplementing Your Retirement Income With IRAs

provided by: Investopedia

Many Americans to some extent depend on Social Security to finance their retirement years and to provide their beneficiaries with financial support; however, according to projections made by the Trustees of the Social Security Fund, the fund assets will begin to be depleted by 2027 and are projected to be exhausted in 2041. While some of us depend on employer-sponsored retirement plans to supplement our retirement income, you are, as an individual, able to supplement your retirement nest egg by funding personal retirement plans such as Individual Retirement Accounts (IRAs). Let's look at some of the features and benefits of IRAs.

Traditional IRAs
A Traditional IRA may be funded by an individual who receives taxable compensation during the year and is under the age of 70.5. If you are married and not currently employed, your spouse may fund your Traditional IRA on your behalf, providing you file a joint income-tax return. You may be able to take a deduction on your income tax return for contributions made to your Traditional IRA if you meet certain requirements. The ability to deduct your contribution is usually dependent on your tax-filing status (i.e. 'married', 'single' or 'married filing separately'), your income and whether or not you participate in an employer-sponsored retirement plan, such as a 401(k) plan.

In addition to funding your Traditional IRA with annual contributions, you may also fund it with assets from your employer-sponsored retirement plan, such as qualified plans, 403(b), 457(b) plans, SEP and SIMPLE IRA plans. Generally, you are allowed to distribute assets from qualified plans, 403(b) and 457(b) plans only if you experience a triggering event. Also, if you inherit retirement assets from your deceased spouse, you may be able to rollover these into your Traditional IRA.

To be sure, consult your employer or plan administrator to determine what the triggering events are for the plan in which you have assets. Your plan administrator should also be able to tell you if the assets are eligible to be rolled over to your Traditional IRA.

Roth IRAs
The Roth IRA - sometimes referred to as the back-ended IRA because the tax benefits are not received up front like they sometimes are with a Traditional IRA - is similar to a Traditional IRA in many respects. There are, however, also marked differences. Some of these are the following:

  • • You are able to fund your Roth IRA even after attaining the age of 70.5.

  • • You are not required to start distributing assets when you reach age 70.5. (For Traditional IRAs, when you reach the age of 70.5, you must start taking required minimum distributions from the account.)

  • • You cannot take a deduction on your income-tax return for contributions made to your Roth IRA.

  • • You can make annual contributions to your Roth IRA only if your modified adjusted gross income is less than a certain amount:

  • $169,000 if you are married and file a joint income-tax return.

  • $10,000 if you are married and file separate income-tax returns and you have lived with your spouse at any time during the year.

  • $116,000 if you are filing your status as single, you are the head of a household, or a qualifying widow or widower or you are married, and filing separate income tax returns and you did not live with your spouse at any time during the year.

  • You may also fund your Roth IRA with conversions. These are assets that were already in your Traditional IRA.

    Your annual Traditional and Roth IRA contributions must be made by your tax-filing deadline, which is usually Apr 15 of the following year.

    Annual Contribution Limits (Excluding Rollover Contributions):
    For years 2002 and beyond, the contribution limit to your Traditional or Roth IRA is the lesser of 100% of earned income or the following:

    Year Contribution Limit Additional Catch-Up Amount
    2002 $3,000 $500
    2003 $3,000 $500
    2004 $3,000 $500
    2005 $4,000 $500
    2006 $4,000 $1,000
    2007 $4,000 $1,000
    2008 and after $5,000 $1,000
    Potential cost-of-living-adjustment (COLA) increase in increments of $500 for tax years beginning 2009. COLA based on the consumer price index.

    If you are age 50 or older by the end of the year of which the contribution is being made, you may also contribute an additional amount, referred to as a catch-up contribution.

    The Choice
    Making the choice between a Traditional and a Roth IRA is not a difficult one. The factor that you will most consider is the timing of the income tax benefit. With a Traditional IRA, the tax benefit is usually taken when the contribution is made to the IRA. For the Roth IRA, because you cannot take a tax deduction for the contributions made, qualified distributions are tax free. If you are unable to take a deduction for a contribution made to a Traditional IRA, it may make better sense to contribute to a Roth IRA instead. Your financial advisor may even decide that a combination of both is in your best interests.

    Should you decide later that you contributed to the wrong type of account, you can always change your mind and move the contributions to the other type of IRA by means of a recharacterization, providing the recharacterization is completed by your tax filing deadline, including extensions. Should you decide to recharacterize your IRA contribution, you must contact your IRA custodian to determine its documentation and procedural requirements.

    IRAs have been the primary source of funding retirement nest eggs for many Americans. In fact, the Investment Company Institute reported that retirement savings account for almost 40% of all household financial assets with a balance of $17.4 trillion dollars as of the second quarter of 2007, and IRAs held $4.6 trillion of this amount as .If you are considering adding to your IRA, be sure to consult with your financial advisor, to ensure that your decisions are financially sound. Your financial advisor will help you to choose the IRA that is better suited for your financial profile, and help you to make other important financial decisions.

    by Denise Appleby, CISP, CRC, CRPS, CRSP, APA

    Denise Appleby is a retirement plans consultant, freelance writer and editor. Before starting her own business, Appleby Retirement Consulting, Denise worked for Pershing LLC for almost 10 years. While at Pershing, Denise rose to the rank of vice president, and held many positions including retirement plans product manager, manager of the retirement plans technical assistance group and retirement plans training manager. Appleby Retirement Consulting provides technical assistance to financial institutions and financial professionals; content for newsletters, websites and magazines; and technical editing services for books and other retirement plans material. Denise holds several retirement professional designations.

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