This year marks the 40th anniversary of the Individual Retirement Arrangement (IRA). In 1974 via the ERISA law, Congress made this new type of retirement plan available for employees whose employers who could not provide them with the traditional type of retirement plan. In 1981, the plans were made generally available to all taxpayers. The Tax Reform Act of 1986 limited the deductibility of IRAs by income.
1997 saw the launch of the Roth IRA, as a part of the Taxpayer Relief Act of 1997. This type of IRA came with no deductibility, but earnings (and contributions) would be tax free upon distribution, following the rules associated with the accounts.
With the exception of changes to limits of contributions, income limits, and catch-up provisions, little has changed for these accounts since 1997, with the exception of the introduction of the Roth-IRA-like myRA account that was established in 2014 for the 2015 tax year.
According to information from the Employee Benefit Research Institute, as of the most recent data available (2012), 19.9 million Americans had at least one IRA account, and the total amount of money held in those accounts was approximately $2.09 trillion.
The primary benefits of IRAs not changed, with regard to how an investor should use these IRA accounts. A recent report by Fidelity Investments indicated that as many as 61% of all investors are confused about which type of IRA will best help them meet their retirement goals. Listed below are the key items that you need to keep in mind as you consider IRAs, whether traditional deductible, non-deductible, or Roth. These accounts represent a powerful option for the average investor, and it is important that you understand how to use them.
- Make contributions early in the year if you can. A year’s worth of tax-advantaged compounding on each annual contribution over the course of your pre-retirement life can impact your results dramatically. For example, a 35-year-old who makes the maximum annual IRA contribution every January 1 could accumulate $631,025 after 30 years. If that same person waits until December 31 to make each annual contribution, the accumulation would be $584,282, or almost $47,000 less.
- Even if you’re unable to make the contribution early in the year, you have until April 15 of the following year to make that year’s contributions. Many taxpayers don’t realize that they can make one year’s IRA contribution during the following year. Many times, for various reasons, we are unable to make the contribution to an IRA during the current year. There is an extension allowed for previous years’ contributions. You are allowed, for example, until April 15, 2015 to make contributions for the 2014 tax year. Take advantage of this extension if you need it!
- If your income is above the limit for deductibility, you are still eligible to make non-deductible contributions to a traditional IRA. Depending upon your circumstances, you may not be able to make a deductible contribution to an IRA. This doesn’t make an IRA completely unavailable to you, though. The tax-deferral of the traditional IRA is a very valuable feature, even if you are unable to deduct the original contribution. And Roth IRA contributions are never deductible anyhow, so the back-end non-taxable distribution feature makes up for that.
- Single-income couples can contribute to an IRA for both spouses. Even if only one spouse has an income for the year, as long as the income is within the limits, you can contribute to IRAs for both spouses. This effectively doubles your IRA deduction in these instances.
As valuable as the tax-deferral feature of both the traditional and the Roth IRA is, you are literally throwing money away if you don’t take advantage of these accounts. Don’t allow confusion about contribution limits and eligibility cause you to forego investing in an IRA. Doing so may have a serious effect on your ability to accumulate enough money for a comfortable retirement.