Maximizing Savings in Traditional and Roth IRAs

If you want to have a financially comfortable retirement, it’s up to you to save for it. The tax law helps you do this by offering breaks for setting aside money in IRAs. With traditional IRAs, you receive a tax deduction when the money goes in. For Roth IRAs, you can create tax-free income, although contributions are not tax deductible. Use these plans to add significantly to your retirement savings.

Contribute the maximum

The tax law sets limits on how much money you can put into an IRA each year. The dollar limit can be directed into a traditional IRA or a Roth IRA or split between them. For 2007, the contribution limit is $4,000. Those who will be at least 50 years old by the end of 2007 can add another $1,000.

In 2008, the contribution limit increases to $5,000 (with a $1,000 catch-up amount). After 2008, the regular contribution limit of $5,000 will be adjusted annually for inflation (the catch-up amount will remain at $1,000).

Contributions can begin at any age you have earned income from a job or self-employment. Contributions can continue to be made to a Roth IRA as long as you have earnings, regardless of your age. Contributions to a traditional IRA cannot be made past age 70½, even though you’re still working.

Income limitations for contributors. Even if you’re willing and able to put money into an IRA, the tax law may not allow it.

• For traditional IRAs, those who are active participants in qualified retirement plans (e.g., a 401(k) through an employer) are barred from deductible IRAs if their modified adjusted gross income exceeds set limits.
• For Roth IRAs, no contributions are allowed if modified adjusted gross income exceeds other limits.

Those barred from deductible and/or Roth IRAs can still fund nondeductible IRAs; there are no income limits in this case.

Make sound investments

Putting money into IRAs is only half the equation for obtaining retirement income. The other half is making sound investments that will grow your money. Take the time to learn about your investment options, understanding such concepts as risk and diversification. Avoid:

• Foreign investments. Foreign equity mutual funds may pay foreign taxes, but you won’t receive any benefit, effectively losing money because of this expense.
• Municipal bonds. Holding them in IRAs effectively converts tax-free income (interest on muni bonds) into taxable income (when IRA funds are withdrawn).
• Collectibles. These investments are barred for IRAs, so putting money into them will result in being treated as a taxable distribution.

Use the IRA calculator (link to our calculator) to see how much your contributions can grow over time.

Leave funds in IRAs as long as possible

It may be tempting to use IRA funds to buy a home or pay for education, resist! Yes, the law waives the 10% penalty on early distributions (amounts withdrawn before age 59½) taken for certain allowable purposes. But using IRA money for nonretirement purposes defeats the reason for making contributions in the first place. Once money is withdrawn, after 60 days it cannot be replaced. The opportunity to build up savings on the amount withdrawn is lost forever.