I often get questions from my students at the University about retirement savings. Most of my students are under the age of 50, so the answers to their questions are a bit different for some retirement plans. One of the more frequent questions that have come up lately concerns the taxability of retirement savings.
The most common type of retirement savings plan is the traditional IRA or 401K. Contributions to these types of plans are tax deductible up to a prescribed limit. In 2013 the limit is $5,500 ($6,500 for those over 50). Traditional IRA contributions reduce adjusted gross income on your return. You don’t need to itemize deductions to take it on the return.
Subsequently, withdrawals from these plans are taxed as ordinary income. There are also requirements on these plans that withdrawals must commence once the owner turns 70 1/2. Typically, this is an advantage since the tax deduction for the contribution to the plan will be taken when the taxpayer is at a higher tax bracket than when they will be withdrawing the funds from the plan in retirement. However, many of my colleagues at the university are in their 70’s still working. They can defer withdrawals from the University plan until they retire, but they have to start withdrawing their savings from traditional IRAs from earlier employers while they are still at the higher tax bracket.
Since 1997, we have had Roth IRAs, which work with post-tax dollars. Contributions to Roth IRA plans are not tax-deductible. Although that is a big disadvantage over the traditional IRAs, there are some real benefits to Roth IRA plans. One is that Roth IRA contributions may be withdrawn at any time without taxes or penalties, and Roth IRA earnings may be withdrawn tax-free and penalty-free once you reach age 59 1/2 and the account has been open for at least five years.
An additional advantage of the Roth IRA is that you never have to make withdrawals. There is no requirement to start withdrawals at 70 1/2 or at any age, like with traditional IRAs. You can leave the funds to your heirs.
As with the traditional IRA, Roth IRAs carry a limit on the amount of annual contributions. In 2013, the maximum contribution is $6,500. The contributions must come from taxable earnings. Congress has limited who may contribute to Roth IRAs.
Taxpayers must not exceed certain limits in taxable earnings in order to be eligible to contribute to a Roth IRA. The limits in 2013 are $127,000 for single taxpayers and $188,000 for joint returns. I remind my students at the University that if they will have higher earnings later in their career, they can make Roth IRA contributions while they are under the limits, and their retirement savings are still protected tax-free even if their earnings exceed the limits in later years.
I know a number of us at Sun City are still working. If you are a member of the working baby boomers, you may want to consider a Roth IRA as part of your retirement planning.
• Send your questions and ideas to: Sun Day, Frugal Forum Column, P.O. Box 7505, Algonquin, IL 60102, or, by email to: thefrugalforum@gmail.com
