As of the beginning of 2005, anybody who makes any money working can contribute up to $4,000 a year in an individual retirement account (IRA). An IRA is a tax-deferred type of retirement savings plan, meaning you don't pay taxes until you withdraw from the fund. Of course, this money can only be contributed if you work. If you make $4,000 a year mowing lawns and shoveling snow, but never report a penny of it, those earnings don't make you eligible to contribute to an IRA (they could, however, get you in trouble with the IRS). Currently, if you earn less than $4,000 a year, the maximum amount you can contribute is the amount you've earned. If you earn $1,650 scooping ice cream at Ben & Jerry's, for instance, that's the amount you can stash in an IRA. However, as of 2005, if you're married, but not working, your spouse can contribute up to $4,000 a year for you, or $8,000 total for the family.
IRAs used to be the hotshot investment vehicles. Things changed, though, when lawmakers got cranky and dumped all kinds of restrictions onto them in 1986. Back in the good old days, anybody could deduct his or her IRA contributions. Now the money you contribute might be tax deductible, but it might not be. Here's how it breaks down:
If you're single and do not have an employer-sponsored retirement plan, you can put up to $3,000 a year in an IRA. Under the recent income-tax revision, the $3,000 contribution limit of 2004 increases in stages until it reaches $5,000 for years 2008 and after. The full contribution is a dollar-for-dollar deduction from your taxable income on your income tax return.
The incremental increases are as follows:
|Under Age 50||Over Age 50|
|2004: $3,000||2004: $3,500|
|2005-2007: $4,000||2005: $4,500; 2006-07: $5,000|
|2008 and beyond: $5,000||2008 and beyond: $6,000|
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An Individual Retirement Account is a retirement savings plan in which you can contribute up to $3,000 per year in 2004. This limit increases in stages until it reaches $5,000 for years 2008 and after. Funds can grow tax deferred until withdrawn at retirement. A Roth IRA varies from the traditional one in that the money you put in it is taxable, but the withdrawals are not. Roth IRAs are increasing in popularity.
After 2008, the limit will increase in increments of $500 annually to keep pace with inflation.
- If you're single, covered by an employer-sponsored plan, and your annual adjusted gross income is $44,999 or less in 2004, you can contribute up to $3,000 to your IRA and deduct the full amount. If your income is between $45,000 ($65,000 for joint filers) and $54,999 ($75,000 for joint filers), the deduction is pro-rated. If you make more than $55,000 a year, you can contribute, but you get no deduction. These cut-off numbers will gradually increase to $50,000 (take the full deduction) to $60,000 (take no deduction) by the year 2005.
A person who has no income, but receives alimony, also is eligible to contribute to an IRA.
- If you're married and file jointly, have an employer-sponsored plan, and your annual adjusted gross income is $64,999 or less (thanks again, Uncle Sam), you can deduct the full amount. The figure is pro-rated from $65,000 to $74,999. After $75,000, you can't take any deduction.
- For workers over age 50, the 2001 tax bill provides a “catch-up” provision for those contributing to an IRA. In 2005, workers who are over age 50 can contribute an extra $500 (for a total of $4,500) to an IRA. The “catch-up” increases to $1,000 for 2006, 2007, and 2008 so that workers can contribute a total of $5,000 in 2006 and 2007 and then $6,000 in 2008.
- If your spouse doesn't have a retirement plan at work and you file a joint tax return, the spouse can deduct his or her full $3,000 contribution until your joint income reaches $160,000. After that, the deduction is pro-rated until your joint income is $180,000, at which time you can't deduct the IRA contribution.
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A tax-deferred investment is one on which you'll pay no tax on income or gain until you withdraw the money. A tax-deductible investment is one that reduces the amount of your current taxable income.
Even if you can't deduct the contributions, they still help out with taxes because they're tax deferred. It's not as great as tax deductible, but it's the next best thing. IRAs are good savings vehicles, but if your IRA contributions aren't deductible, make sure you take advantage of the programs on which you can get a tax deduction, such as 401(k)s, first.