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Of all the retirement plans, the Traditional IRA and the Roth IRA are the most accessible retirement saving vehicles for funding one's retirement nest egg. IRAs were created with less complex rules than other retirement plans and usually requires none of the administrative requirements that usually apply to employer plans. Further, unlike employer plans- your clients need not rely on another party to create the opportunity to fund their IRAs. As you assist your clients with preparing to fund their IRAs, be mindful of the basic requirements that must be met.

How Much Can Added

An individual may contribute up to 100% of his/her eligible compensation/income, up to $4,000 for 2007 ($5,000 for 2008). If the individual reaches age 50 by the end of the year, he/she may contribute an additional $1,000. This additional $1,000 is referred to as a catch-up contribution. $4,000 may not seem like much. But making contributions to an IRA each year will eventually add up to a significant amount of savings by the time the IRA owner is ready to retire. Let’s look at examples of individuals who save $4,000 each year, up to age 70, assuming a rate of return of 5%

The person who starts at age 30, would accumulate $507,359.05 by age 70, whereas the person who starts saving at age 50, would accumulate only $138,877.01.

Procrastination Makes it Harder to Save

Starting earlier not only allows individuals to save more overtime, but it reduces the financial burden of saving. For instance, assume that an individual wants to save $1,000,000, and wants to add level amounts to his/her account each year, at a 5.5 % rate of return. The amount he/she would need to add to the account increases with each year the individual procrastinates. Let’s look at some examples:

Calculator available at www.72t.net

As demonstrated, an individual who wants to save $1,000,000 would require a savings of only $3,849 per year over a 50 year period. Compare that with a required saving of $27,184 per year for an individual who wants to reach that same amount, but has only a  20-year period to do so.

Eligibility Requirements

In addition to having eligible compensation/income for the year, individuals must meet other requirements in order to contribute to an IRA. The requirements depend on the IRA to which the individual wants to contribute.

• Age: For Traditional IRAs, contributions can be made for the years preceding the year the owner reaches age 70 ½. There are no age limitations on Roth IRA contributions.
• Income Cap: There is no income cap on funding a Traditional IRA. However, for a Roth IRA, the following modified adjusted gross income (MAGI) limits apply.

Contribution Requirements

• Deadline: Contributions for any calendar year must be made to an IRA by April 15th of the following year.  For instance, a contribution for 2007 must be made by April 15, 2008.

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The postal rule applies to IRA contributions. This means that if the contribution is mailed by tax filing due date, using the US postal service, or any of the following designated private delivery services, the contribution will be considered received in a timely manner, even if the financial institution receives it after the deadline.

1. Airborne Express (Airborne): Overnight Air Express Service, Next Afternoon Service, and Second Day Service;
2. DHL Worldwide Express (DHL): DHL "Same Day" Service and DHL USA Overnight;
3. Federal Express (FedEx): FedEx Priority Overnight, FedEx Standard Overnight, FedEx 2 Day, FedEx International Priority, and FedEx International First; and
4. United Parcel Service (UPS): UPS Next Day Air, UPS Next Day Air Saver, UPS 2nd Day Air, UPS 2nd Day Air A.M., UPS Worldwide Express Plus, and UPS Worldwide Express.

• Cash Requirement: IRA contributions cannot be made in-kind. This means individuals cannot use their favorite stock or mutual fund to make contributions.  Instead, the contribution must be made in cash. Most (if not all) financial institution accept checks, and some accept money orders or other instruments. Individuals may also make contributions VIA automated clearing house (ACH) or federal fund wire. Availability should be checked at each financial institution.

Tax Credit Available for Some
If the individual's MAGI falls below certain amounts, he/she may be eligible to receive a non refundable tax credit of up to 50% of the contribution made to the IRA and any salary deferral contributions made to an employer sponsored plan. This is referred as the Saver’s Credit. The tax credit is capped at $1,000, and the percentage for which the individual is eligible depends on his/her MAGI. The following table provides the percentage of tax credit available for individuals within the indicated MAGI ranges.

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Other requirements for receiving the credit apply. These include the following:

1. The individual must be at least 18 years of age the year for which the credit is claimed
2. The individual cannot be claimed as a dependent on someone else’s tax return
3. The individual cannot be a full time student

Refer to IRS Form 8880, to determine the amount of credit for which individuals are eligible. Additional details on the Saver’s Credit are available in IRS Announcement 2001-106 and the instructions for Form 8880.

Deducting IRA Contributions
While Roth IRA contributions are not deductible, Traditional IRA contributions may be, depending on several factors. These are as follows:

1. Whether the individual is an active participant or if he/she is married to someone who is an active participant. One is considered an active participant if he/she participates in an employer sponsored plan. The rules vary for each type of plan, for instance, one is considered an active participant in a SEP IRA for the year the SEP contribution is made to one's account, even if it is made for the previous year.
2. If the individual are an active participant, his/her tax filing status and MAGI

The following chart includes the MAGI’s and applicable deductibility.

An individual's Traditional IRA contribution is fully deductible if he/she is not an active participant, and he/she is not married to an active participant.

Nondeductible Contributions- an Option
If an individual  is ineligible to deduct his/her IRA contribution or contributes to a Roth IRA, he/she could consider making a nondeductible contribution to a Traditional IRA. Distributions of these amounts are tax-free, but must be pro-rated with pre-tax Traditional, SEP and SIMPLE IRA assets to determine how much of a distribution is attributed to the nondeductible balance. For any year that an individual makes a non-deductible contribution to a Traditional or SEP IRA, he/she is required to file IRS Form 8606.

 

Tip: If an IRA balance includes amounts attributed to nondeductible contributions or rollover of after-tax amounts, the owner will need to file Form 8606 for any distributions that occur from his Traditional, SEP or SIMPLE IRA. This applies even if the IRA from which the distribution is made does not include these nontaxable amounts.  Roth IRAs are not included in this requirement

 

Conclusion

Contributing to an IRA is a great way to fund one's nest egg. An individual should fund the IRA that is more suitable for his/her financial profile.To get the best of both options, one may split contributions between both types of IRAs if eligible. Aggregate contributions do not exceed the contribution limit in effect for the year. After making the contribution, the individual check his/her account statement for that month, and if it was not processed properly, contact the financial institution immediately so that they can make any required adjustments.