What is an IRA Account? With constant news regarding the social security system being in jeopardy, more people are looking for alternatives and supplements for retirement income. One easy way to save for retirement is through an IRA. An IRA is an individual retirement arrangement (although most think it stands for account). The purpose is for individuals to be able to contribute annually to retirement savings and provides tax advantages in doing so.

There are two types of IRA accounts, the traditional and the Roth IRA. Today we are taking a look at the traditional IRA account.  Why just the traditional?  Mostly because I’ve wrote A LOT on the Roth and variety is the spice of life. 

Savings to Your IRA Account

Almost anyone who has earned income can open and begin contributing to an IRA. Even minors are permitted to open IRA accounts as long as they have at some point earned income. The exception is that the IRA must be established before a person is 70 ½ years old.

How Much Can be Saved

The maximum amount that can be contributed to an IRA account each year is $5000. Once a person reaches age 50, they can begin contributing an additional $1000 annually for a total of $6000 in annual contributions.* There are penalties for early withdrawal, so once the money is invested in an IRA the investor should plan the money staying in the IRA account. Unlike a traditional savings account, withdrawals can not be made on a regular basis..

*contribution limits are subject to change

IRA Benefits

There are many benefits to opening an IRA account as early as possible:

• contributions are not taxed until the money is withdrawn
• the earlier one starts saving, the more money they will have saved or put aside for retirement
• the contribution reduces income for tax purposes
• there are exceptions for early withdrawal, so if you have an emergency you may be able to access the funds

How an IRA Works

Originally IRA’s were thought of as a way for those who do not have an employee sponsored 401(k) or 403(b) plan, to save for retirement. However, many people with a work related retirement plan also open an IRA for additional retirement savings.

Typically an IRA is set up through a bank or with the help of a financial adviser. It’s as easy as going online for an application and making an initial deposit. Once the account is open then the investor can decide how to fund the account. The most common and easy way is through CD’s. Stocks and bonds are also a great way to fund an IRA, however one must be familiar with the workings of the stock market or should consider hiring a broker.

Why Save?

With constant insecurity about the social security system and the ever lengthening life expectancy rate, people need more money for retirement then ever before. Establishing an IRA account as early as possible is a great way to help plan for the retirement life that you envision. If you haven’t started saving yet, there’s no better time to look into opening your own IRA account.

Nobody likes paying taxes. Not that they don’t pay for some things we definitely need. Roads, some kinds of healthcare, representation in the government, and lots of other things America needs to keep itself running. They are a necessary evil in a civilized society.

But still – we all hate paying them. Anybody with me?  And if possible, I think everyone would like to pay less money into them. And I’m here to tell you that it’s possible to reduce your taxes with a couple different tactics. Some of them may mean the money you’d spend is contributed anyway, but others allow you to keep the money in different ways.

Reduce Taxes Through Your 401k, 403b, or 457

One of the best possible ways to reduce your taxes is to contribute to a 401k or some kind of IRA (like a Roth, SIMPLE, or Education IRA). These retirement-oriented investments allow you to put money away into safe keeping to be withdrawn at a future date. If you leave the money in for the term agreed to by the individual IRA situation, you get to withdraw it completely tax free. So by investing your money into retirement funds before it is taxed, you completely avoid the tax on those dollars and you get to keep the money.

I recently had a client that made a comment that they were being “ate up in taxes” and were looking for anyway to reduce their tax liabilities. The wife was a teacher that had access to a 403b, but was not nearly taking advantage to its full potential. If you are not self-employed, then these employer sponsored plans are your largest resource to reduce your taxes while simultaneously saving for your retirement.

Don’t Forget the Match

Additionally, your employer may offer to match your contributions up to a certain percent. That’s an absolute no brainer. When an employer offers to match your contribution, you should almost always take advantage of that to it’s full extent. It’s like free money. My top recommendation to people looking to lower their taxes is to get involved with some kind of IRA or retirement planning.

Look For All Possible Deductions

Additionally, make sure that you look through the list of possible adjustments to your tax bill every year. You can deduct things like student loan interest paid, classroom related expenses, and other items. There are a number of pages in your tax documentation every year that list the possible adjustments you can take.

Deductions are the other major area to take advantage of when looking to reduce your taxes. There’s a standard deduction for most people, and there are additional deductions that some people may be able to itemize. Things like vehicle expenses, expenses involved with running your own business, interest paid on your mortgage, fees related to investments or tax preparations, or even donations to charity. All of these items allow you some wiggle room in lowering your taxes.

Give Me Some Credit

Once you’ve found all the ways to save money on taxes, it’s a good idea to look at potential tax credits. One that most people can take advantage of is the Lifetime Learner tax credit. This tax credit allows you to write off the costs of college classes no matter what your level of education. There’s also no requirement that college classes be germane to your area of study or employment. If you work as a computer programmer but have an interest in history of the presidents of the United States, classes on that topic would likely qualify you for the Lifetime Learner Credit.

Other credit that you might apply for is if you make energy efficient changes to your home.  The 2011 energy tax credits allow you to deduct a percentage of the cost you make to home improvements such as windows, insulation, solar panels and geo-thermal units.

If you’re not sure what deductions or credits you may apply for,  find a good accountant to help you out.  Many people I talk to think it’s not worth hiring an accountant to do their taxes, but what if they introduce you to a few deductions or credits that you weren’t aware of?  The fee that might pay for them to prepare your taxes could be offset by them.  It never hurts to ask, especially if it may help reduce your taxable income.

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In December, President Obama reinstated the Individual Retirement Account Charitable Rollover through 2011 as part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. Originally introduced in 2006 as part of the Pension Protection Act, this stipulation allows individuals aged 70 ½ and over to donate funds up to $100,000 from their IRAs to public charities without being mandated to report it as taxable income.  Going forward, this renewed provision could mean a lot of savings to a lot of people.

Rules on Charitable Donations From Your IRA

There are, of course, certain rules to follow if you are hoping to take advantage of this extension:

The new law also has a special rule allowing taxpayers to make retroactive IRA charitable donations in January 2011 and have them count as being made on December 31, 2010. This means if you haven’t reached the $100,000 cap in 2010, you still have the opportunity to do so.

Who Should Take Advantage of the Charitable Rollover Option?

Taxpayers typically must itemize in order to claim charitable deductions. The majority of filers of all ages instead elect to claim the standard deduction. Thanks to the rollover, these filers won’t have to pass up this potential deduction.

Those who face donation limits based on income will also appreciate the rollover. Usually, you cannot donate more than 50% of your adjusted gross income (and sometimes you are limited to 20-30%). However, when the money goes directly from your IRA to the charity as a qualified charitable distribution, it is not counted against that limit because it is not counted in your gross income. If you are someone who usually gives up to half of your adjusted gross income, you can now give up to $100,000 more from your IRS. This could enable you to avoid paying a substantial amount of money in federal income tax on IRA distributions for 2010 and 2011.

Taxpayers who are forced to take minimum withdrawals but don’t really need that income can fulfill up to $100,000 of the distribution requirement with a charitable donation.

In short, you have been given the opportunity to continue making qualified charitable distributions from your IRA or Roth Account to nonprofit organizations without ever having to count that money as income on your tax return. You can do this for the current year and, thanks to the one month 2010 extension, for last year as well.

IRA Charitable Donations Rules Concluded

Since this provision was first put in place, Americans have made millions of dollars of new contributions to worthwhile causes such as social service programs, cultural institutions, schools, and more. This benefits the greater society. And, happily, it also benefits you.

This is most certainly the gift that keeps on giving!

This information is not intended to be a substitute for specific individualized tax advice.  We suggest that you discuss your specific tax issues with a qualified tax advisor.

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With the world economy on shaky ground, many people have been focusing on the financial here and now more than the financial future. This is certainly understandable as people have to be able to survive today in order to live to see tomorrow, but if at all possible, it is important to look to the financial future. After all, a bit of planning today can make for a much sunnier tomorrow. Here are a few ways to buy long-term investments without breaking the bank.

Don’t Get a Job, Get a Career

It’s a fact of life that a having a college degree is becoming increasingly more mandatory for career-seekers. Sure, there are still some positions out there that do not require a college education, but they are few and far between. In order to make money in the long run, it is necessary that you spend money on higher education now. However, there are ways to go about earning a degree without draining your bank account. The first option you may want to consider is online school. Virtual classrooms are becoming quite popular with traditional and non-traditional students. Online learning is ideal for people who work or take care of children during the day, as it usually allows you to complete assignments at your own pace. Another money-saving aspect to consider is finding a college scholarship. Schools across the country offer thousands of dollars worth of scholarship money each semester – sometimes for just being who you are. Coupled with finding affordable ways to pay for tuition, earning a degree is something that should not be passed up. It is the ultimate investment in your future.

Never Say No to Free Money

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For those who are currently employed by a company that offers 401k matching programs, be sure to take the full advantage of this benefit. While it may hurt a bit to reduce your cash flow, the 401k matching system is one of the best ways to get a return on one’s investment. There are very few occasions in life where one is offered cash for doing practically nothing – a 401k matching system is one of these occasions. So make some time to speak to your human resources rep at work and find out how to maximize this benefit. By contributing a few percentage points of your income to a 401k plan, especially one that is part of a matching system, you can make a good long-term investment without breaking the bank.

Consider Investing in an IRA

Investing in an IRA is a good way to invest a relatively small amount of money in a long-term savings plan. IRA’s have a much lower maximum allowable contributions than 401k’s. This means that one cannot invest as much money in a given year. The benefit of IRA’s, however, is that they are a good investment strategy for people who are not employed by companies that offer 401k systems. Those who are self-employed, however, can use SEP-IRA’s to invest percentages of their income, offering them the ability to invest much more on an annual basis than is allowed in traditional IRA’s.

Think of Your Car as a Long-Term Investment

Let’s face it, most people simply can’t live without a car and many families rely on owning more than one car. Sure, there are some folks who live in the middle of large cities with excellent public transportation systems, but this is not the case for most people. Buying a new car can be a real pinch for those who are trying to squirrel away some cash for a rainy day or for retirement, but it is possible to think of one’s car as an investment. When researching new car deals, don’t get taken by the bells and whistles. Do you really need multiple DVD player screens and a sound system to rival the one that you have in your house? Probably not. It is best to purchase a car from a company with a good track record of manufacturing safe and dependable vehicles. Buying a used car is an acceptable option for a lot of people, but you are never completely certain what the car’s history is in these cases. It is recommended that in order to have the piece of mind that you know where your car is coming from, and to really treat it as a long-term investment, it is better to shop around for a good deal on a new vehicle.

No matter how you plan to invest, finding a great option for your long-term investments is an important thing for most people. This will help you have the money there when you really need it.

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IRA’s (Individual Retirement Accounts) are a vital tool in retirement planning.   Younger investors may prefer the Roth IRA, while baby boomers may choose the traditional IRA.   When you retire, you may want to convert all your retirement assets into a rollover IRA.   So many choices and even more options can leave somebody overwhelmed on what the right IRA to choose when planning for retirement.   If you have an IRA, be sure to avoid these 12 mistakes:

1. Not taking advantage of the stretch distribution option or not establishing it properly.

The “stretch IRA” is a way for each IRA beneficiary to maximize payouts over his or her entire life expectancy. Properly designating beneficiaries and informing them of the IRA owner’s “stretch” intentions are key to making this strategy work.

2. Not naming or updating IRA beneficiaries.

Not listing primary and contingent beneficiaries may result in the distribution of the IRA assets to the IRA owner’s estate, resulting in accelerated distribution and taxation. Not keeping beneficiary designations current and coordinating them with other estate planning documents can also lead to conflicts and unintended results.

3. Making inappropriate spousal rollovers.

Most IRAs list the owner’s spouse as the primary beneficiary. One of the most popular strategies for a spousal beneficiary is simply to roll the inherited IRA into his or her own IRA. But in some cases it can be more tax efficient for a surviving spouse to keep the IRA as an inherited beneficiary IRA or disclaim the assets, thereby allowing them to pass to the contingent beneficiary.

4. Not taking advantage of “IRD” if you are a beneficiary.

Upon the death of the IRA owner, his or her IRA is included in the estate, creating an estate tax liability (if applicable) as well as an income tax liability for beneficiaries. Many IRA beneficiaries do not realize that IRAs are considered “Income in Respect of a Decedent” (IRD), according to Section 691(c) of the IRS Code. The IRD designation allows beneficiaries to take a federal income tax deduction for any estate taxes paid on the IRA’s assets, thus limiting double taxation of the IRA assets.

5. Rolling low-cost-basis company stock into an IRA.

Distributions from a qualified plan such as a 401(k) are generally taxed as ordinary income; federal income tax rates range from 10% to 35% (as of 2009). If company stock is rolled into an IRA, future distributions are taxed as ordinary income. If, instead, the company stock is taken as a lump-sum distribution from the qualified plan, only the cost basis of the stock is taxed as ordinary income. This is called Net Unrealized Appreciation. (Note: The distribution must be taken as stock, not cash.) Unrealized capital appreciation (the difference between the cost basis and current fair market value) is not taxed until the stock is sold, upon which it would be taxed as long-term capital gains, which are taxed at a lower rate than ordinary income (at 2009 tax rates). Be sure to talk with your tax advisor.

6. Not taking advantage of a Roth IRA.

A Roth IRA is a potentially valuable retirement resource. Not only are qualified withdrawals tax free, but Roth IRA distributions do not impact the taxability of Social Security, and Roth accounts pass to beneficiaries tax free as long as the account passes the five year rule for qualified distributions. There are income limits that affect eligibility for a Roth IRA, so be sure to talk this option over with your financial advisor.

7. Not taking advantage of increased contribution limits.

The contribution limits for 2009 are $5,000.  IRA owners age 50 or older can make an additional $1,000 “catch-up” contribution in 2009. Roth IRA limits and traditional IRA limits are the same.

8. Assuming that a nonworking spouse cannot contribute.

The truth is that separate “spousal” IRAs may be established for spouses with little or no income up to the same limits as the working spouse.

9. Missing important dates.

Estate taxes, if applicable, are due nine months after the IRA owner’s death. The same deadline applies to beneficiaries who wish to disclaim IRA assets. By September 30 of the year following the year of the owner’s death, the beneficiary whose life expectancy will control the payout period must be identified. Generally, IRA beneficiaries who want to receive distributions over a life expectancy must begin taking required distributions by December 31 of that same year.

10. Taking the wrong required minimum distribution (RMD).

IRA owners in their seventies are required to take the RMD out of their accounts each year, based on the value of all their non-Roth IRAs. Those who do not take enough out each year may be subject to a federal income tax penalty of 50% of the amount that should have been taken as an RMD but was not. Consolidating retirement assets may make it easier to manage these distributions. Current law allows a one-time suspension of the requirement to take an RMD for 2009. RMDs must resume in 2010.

11. Placing the title of an IRA in trust.

Making a trust the actual owner of an IRA causes immediate taxation — including the 10% penalty tax if the IRA holder is under age 591⁄2.

12. Paying unnecessary penalties on early (pre-age 591⁄2) IRA distributions.

As long as withdrawals are made in accordance with the requirements of IRS Code Section 72(t), there is no need to pay penalties on distributions from IRAs before the owner is age 591⁄2. Section 72(t) allows for three calculation methods to determine substantially equal periodic payments based on the owner’s life expectancy. Payments must continue for 5 years or until age 591⁄2, whichever is the longer period of time.

photo by Charles NJC

*Restrictions, penalties and taxes may apply.  Unless certain criteria are met, Roth IRA owners must be 59 1/2 or older and have held the IRA for 5 years before tax-free withdrawals are permitted.