Invest in your future: Don’t delay opening an IRA
BY TERRY SAVAGE SUN-TIMES COLUMNIST Jul 14, 2006
Updated: May 3, 2013 12:14PM
Originally published: August 7, 2001
It’s last call for 1998 IRAs.
You say you can’t afford to contribute to an IRA?
You can’t afford not to contribute. A $2,000 IRA contribution works out to $38.46 per week. If you start at age 21 and contribute until you’re 71 - at an average annual growth rate of 10.6 percent - today’s 21-year-old contributing $2,000 to an IRA every year will build up a nest egg of $3.1 million.
I hope that caught your attention.
Even if you’re long past your 20s, an annual IRA contribution can grow dramatically. If you start at age 40, the same investment would grow to nearly half a million dollars by the time you reach age 71.
But time is running out for your 1998 contribution. It must be made by the April 15 tax deadline.
Here are some answers to the questions most people ask me about IRAs.
Q. Where should I open my IRA account?
A. Any bank, brokerage firm or mutual fund will make it very easy for you to open an IRA account.
It’s just like opening a regular account, except that after your name the account will have the designation: IRA. That means you won’t have to pay taxes on the gains in the account each year, and it also means that you can’t take any money out without taxes or penalty before age 59 1/2 (except for Roth IRAs).
Q. What’s the difference between a traditional IRA and the new Roth IRA?
A. The traditional IRA is a tax-deductible contribution of up to $2,000 of earned income. So part of your contributions consists of money that might have gone to the government to pay taxes. Your investment grows tax-deferred over the years - and you’ll pay ordinary income taxes on the money when you take it out at retirement.
Only people who are not covered by a company retirement plan (or who have incomes below $30,000 on a single return or $50,000 on a joint return) may make a fully tax-deductible contribution to a traditional IRA. That amount increases by $1,000 for 1999 contributions. Non-working spouses may have their own tax-deductible IRAs, even if the spouse is covered by a company plan, if the couple’s income on a joint return is below $150,000.
The new Roth IRA is made with an after-tax contribution of up to $2,000 per year. You don’t get the deduction, but you do get another wonderful benefit: When you take the money out at retirement, the entire amount - including investment gains - can be withdrawn tax-free. You are eligible to make a Roth IRA contribution if you have adjusted gross income below $95,000 on a single return or $150,000 on a joint return. Non-working spouses can put up to $2,000 in a Roth IRA if the couple qualifies with income of less than $150,000 on a joint return.
Q. Can I contribute to both in the same year?
A. Yes. You can divide your contribution, but the maximum total IRA contribution for the year is still $2,000 per person. Why complicate things by opening two ifferent accounts?
Q. What can I invest in?
A. You can open an account at a bank and use a certificate of deposit or a money market account. If you open your account at a mutual fund company, you can choose any of their mutual funds for your IRA account. At a brokerage firm you can buy individual stocks in your IRA account, as well as mutual funds or bonds or other securities. Every financial services company is advertising their IRA plans, so you should have an easy choice. Remember, it’s more important to just get started than to pick the absolute ``best’’
Q. Do I have to invest the whole $2,000 - or can I start with less?
A. You can start with far less. Most mutual fund companies will let you open an IRA account with a $500 minimum. Banks often have lower IRA minimums. But your entire contribution for 1998 must be made by April 15. If you start an IRA for 1999, you can make a small contribution each month, up to $2,000 by April 15, 2000.
Q. Do I have to put all my IRA investments in one place?
A. It’s a good idea to put each year’s contribution in one account. The next year you can add to that account, or open a new one. For instance, you might invest in a growth mutual fund this year, and an international fund next year. If you invest through the same company, you’ll receive all your statements together - even though you have investments in several different funds or stocks.
You should be very careful to keep different types of IRAs separate. For example, you might have a Rollover IRA account with money you transferred from a previous employer’s retirement plan.
Keep that money separate from your traditional IRA or Roth IRA. Yes, it can create a lot of paperwork, but you’ll find it’s worth the trouble to keep accounts separate when you start to take withdrawals.
Q. Should my spouse and I contribute to a joint IRA?
A. There is no such thing as a joint IRA. After all, this is an ``individual’’ retirement account. Who knows if you will still be each other’s spouse when it comes time to retire? That’s why even non-working spouses should open a Spousal IRA - either traditional or Roth - with money from the spouse who is working.
Q. Is it worthwhile to contribute to an IRA if I think I might need the money before retirement?
A. The whole idea of an IRA is to let the money grow until retirement. So you shouldn’t be thinking about taking money out. But in certain situations you can take money out without penalty - even though you’d still be liable for income taxes in a traditional IRA.
With a Roth IRA, you can withdraw money at any time without paying taxes, because you’ve already paid taxes on your contribution.
First-time homebuyers (those who have not owned a home in the previous two years) can withdraw up to $10,000 penalty free. And any amount of money may be withdrawn without penalty if it is used for qualified college expenses in the same year.
You cannot borrow money from an IRA, the way you can with a company 40l(k) plan. Still, this should be a last resort, because when you take money out you not only lose that cash, but all the future growth on that amount.
Q. What if I’m not eligible for a traditional IRA because I’m covered by a company plan, and I earn too much to be eligible for a Roth IRA?
A. Congratulations. First, contribute the maximum - at least up to the company match - to your plan at work. Then you can open a traditional IRA that is not deductible, and put in up to $2,000.
Keep that IRA separate from any other IRAs, because when you withdraw money later in life, you’ll only have to pay taxes on the investment gains - since your contributions were made after-tax.
Q. How does the government know I’ve made an IRA contribution?
A. Well, if its a traditional deductible IRA, you’ll enter that deduction on your tax return. If you make a non-deductible contribution to a traditional IRA, you must file form 8606.
There is no requirement or form to report a Roth IRA. The IRA custodian reports the value of your account each year to the IRS on Form 5498, which will now include a section for Roth IRA information.
Q. What’s the absolute deadline for my IRA contribution?
A. Well, I wouldn’t push it - but a number of mutual fund companies and brokerage firms always advertise that they’ll stay open late on April 15 to accept last-minute IRA contributions. Don’t wait until the last minute. Make your 1998 IRA contribution this week - and let your money start working for you.
Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McDonald’s Corp. and Pennzoil Co. You can send her questions via e-mail at email@example.com. Her second book, published by HarperCollins, is Terry Savage’s New Money Strategies for the ‘90s. Copyright Terry Savage Productions.