Mark Twain once said, "The rumors of my death have been greatly exaggerated."
Like Mr. Twain's rumored demise, the notion that the traditional individual retirement account is no longer a useful part of a financial plan, has been greatly exaggerated.
Contributions to a traditional IRA continue to be a viable financial and retirement planning tool despite non-deductibility for some individuals.
All you need to make a traditional IRA contribution are earnings as an employee or as a self-employed person. The amount that can be contributed for 2006 is the lesser of $4,000 ($5,000 if you have attained age 50) or your earnings from your work. There is no minimum age for making a traditional IRA contribution for tax purposes. If a 16-year-old works for the summer, makes $4,000 and blows it all at the mall, the tax code permits mom, dad or whomever to give him/her $4,000 to contribute to a traditional IRA on his behalf. There is a maximum age for IRA contributions. No traditional IRA contributions may be made for people over 70 1/2, even if they are still working as hard as they were at 30 1/2.
An additional contribution of $4,000 is permitted if the traditional IRA participant has a spouse who doesn't work outside the home. If both spouses are under age 50, the total contribution in this situation is $8,000 and the spouses can divide the amount contributed any way they choose, so long as neither receives more than $4,000 into his/her account.
The question of deductibility is often confusing to many taxpayers. There are two questions that may have to be answered to determine if a traditional IRA contribution is fully deductible, partially deductible or not deductible. The first is: Are you covered by a plan? If the answer is no, then the traditional IRA contribution is deductible regardless of the taxpayer's income.
Whether you are covered by a plan depends on the type of employer-sponsored plan in place. If you're not sure, your employer can tell you because employers must check a box on every employee's W-2 stating whether they are covered.
If the answer is yes and you are covered by a plan but your spouse is not, then only you are exposed to the next test. Your spouse's contribution to a traditional IRA is fully deductible up to new phase-out limits of $150,000 to $160,000 of joint income. If both of you are covered by a plan, then the next test will determine to what extent both of you can deduct your contributions.
Assuming coverage by a plan, the next question that must be answered is: how much is your income? For 2006, taxpayers with adjusted gross income of $50,000/$75,000 (single/married filing jointly) or less, the contribution is fully deductible. For taxpayers with AGI over $60,000/$85,000 (single/married filing jointly), no IRA deduction is permitted. For those with an AGI between those levels, the amount of the deduction is phased out proportionately. There is a $400 floor to the deduction that will apply to those whose AGI is close to the upper limit.
For example, a single person who is covered by an employer's plan has an AGI (excluding the IRA deduction) of $55,000. Since that's 50 percent of the way from $50,000 to $60,000, the taxpayer may deduct $2,000 of a $4,000 contribution (50 percent of $4,000). The other $2,000 of the contribution is non-deductible.
The best part of the traditional IRA deal is the tax-deferred growth potential your investments can enjoy inside the account. Your earnings will grow much faster when not dragged down by the weight of a current tax bill.
Your financial planner can show you whether and how a traditional IRA can fit into your retirement plan.
Ronald Wilson, a certified public accountant and certified financial planner, is a financial advisor with Raymond James Financial Services. Contact him at (561) 844-8448 or e-mail at firstname.lastname@example.org.