We are fast approaching the deadline to make contributions to your 2015 Individual Retirement Accounts. As many people wait until they file their taxes to fund their IRA’s this may not be an ideal time to do so. It has been shown that the earlier you can fund your IRA the better off you will be when you retire as your money will have 12-15 months more to work for you. And many people who wait until the last moment to fund their IRA’s leave the amounts in cash for much longer than they intend to. But funding an IRA late is better than not funding your IRA at all so let us look at some areas that need to be addressed regardless of when you make your contributions.
One of the first things that you need to do before you make an IRA contribution is to understand the differences between the two basic types, ROTH and Traditional. And then the Traditional IRA has a deductible and non-deductible variety. And depending on your income will have a significant impact on what type of IRA you will be able to fund. So now you need to ask yourself what IRA do you qualify for and which one is the best for you?
Your annual income will help determine which IRA is for you so let us begin there. If you are single and earn less than $116,000 or married and earn less than $183,000 you can contribute to a ROTH IRA. This is phased out for both single and married taxpayers, and these figures change annual so check with the IRS on a regular basis.
For Traditional IRA’s anyone can make a contribution. Whether it will be a deductible contribution is also determined by income and if you have a workplace retirement savings plan available to you. For those who have a workforce plan single filers must make less than $61,000 and married couples less than $98,000. And like the ROTH these amounts are phased out so always check with the IRS to make sure you are within the limits. For those who do not make contributions to a workplace retirement plan, IRA contributions are always deductible.
For those who make too much or contribute to a workforce retirement account, there are non-deductible IRA contributions. In this regard, you do not get the advantage of any deductions, but this method does provide a way to a ROTH account through a backdoor conversion.
If you qualify for either a Traditional or a ROTH IRA and are unsure of which to contribute to there is a solution for that as well. In these instances, it is wise to divide your contribution in half and make a contribution to each. That and it is wise to have multiple sources of income in retirement as well divided between taxable and tax-free. If you were to make the full contribution of $5,500, you would place $2,750 in each type of IRA.
So what happens if you make a contribution during the year and then when you file your taxes find out you made too much to qualify for an IRA. It is simple the IRS will allow you to do what is known as a recharacterization. That is a do-over where the IRS will allow you to change to a non-deductible IRA contribution as you would have earned too much for a ROTH or deductible Traditional IRA.
Some people make traditional non-deductible contributions and do not take further action. By doing this, it leaves the IRA vulnerable to the Required Minimum Distributions. If it were converted to a ROTH IRA, it would not be subject to these distributions. Beware of doing the conversions with other taxable IRA assets such as rolled over 401(k) accounts. This is not what it is intended to for so avoid this at all costs.
This raises the question of how long should one leave their assets in a non-deductible IRA before converting it to a ROTH account and how should your assets remain while you are awaiting the conversion? Some people will suggest you make the conversion as soon as possible to avoid any unnecessary taxes while others recommend waiting, at least, a year before you make the conversion. Here I am not sure who is right and who is wrong as there are many professional weighing in on each side of this topic. But regardless of that aspect, I feel you should invest the assets you place in a non-deductible IRA so the funds can work in your favor and simply pay the taxes when you convert the IRA from Traditional to a ROTH.
If your spouse does not work do not forget that provided you make enough to cover both of your contributions, you are each eligible for an IRA. This is key for the spouse who does not work and will help provide an extra source of income in your retirement years.
As asset allocation is extremely important an IRA is essential in keeping balance. IRA’s allow you to hold assets that appreciate in value in a proportion that makes them beneficial. Placing certain equities, REIT’s and High-Yield bonds in an IRA makes great sense and can help balance your overall portfolio. Putting municipal bonds in an IRA makes no sense as these are tax advantaged from the beginning. To better understand what to place and what not to place in an IRA ask a financial planner after you provide them your entire portfolio picture.
While it is never a good thing to not contribute to an IRA, it is wise to plan accordingly. For many tax season means IRA contributions as well as they tend to go hand in hand. If you require additional information or need assistance, please do not hesitate to contact me or leave a comment on this post.
