Build Wealth and Cut Your
Tax Bill
Too | The
clock is ticking down to the tax filing
deadline. The good news: There may still be an
opportunity to save on your tax bill. If you qualify, you can
make a
|
2006
IRA Deadlines and Limits |
IRA and Roth
IRA contributions |
You can contribute up to $4,000 until
April 17, 2007 ($5,000 is you were age 50 on
12/31/06). |
SEP
contributions |
You can contribute up to $44,000 by
April 17, 2007 or by the extended due date (up to
October 15, 2007) if you file a valid extension. (There
is no SEP "catch up" bonus.) |
Age
limits |
You must be under age
70 1/2 at the end of 12/31/06 to contribute to a
traditional IRA. Contributions to a Roth can be made
regardless of age, if you meet the other
requirements. |
2006
IRA |
Phase-Out Ranges |
Traditional IRAs
when active in company retirement
plan |
For married filing jointly between
adjusted gross income (AGI) of $75,000 and
$85,000; For single or head of household, $50,000
to $60,000; For married, filing separately, $0 to
$10,000, if you lived with your spouse at anytime
during the year. |
Traditional IRAs if
spouse participates in employer-sponsored
plan |
Phase-out occurs between AGI of
$150,000 and $160,000. |
Roth
IRAs |
For married filing jointly, $150,000 to
$160,000; For single or head of household, $95,000
to $115,000; For married filing separately, $0 to
$10,000, if you lived with your spouse at anytime during
the year. | deductible
contribution to a traditional IRA right up until the April 17,
2007 filing date and still benefit from the resulting tax
savings on your 2006 return.
Small business owners can
set up and contribute to a Simplified Employee Pension (SEP)
plan up until the due date for their returns, including
extensions.
You also
have until April 17 to make a contribution to a Roth IRA. Here
are the main differences between a traditional IRA and a
Roth:
Contributions to a
traditional IRA are deductible on your tax return depending
on your income and whether you - or your spouse,
if filing jointly - are covered by an employer's
pension plan (see right-hand table). In contrast,
contributions to a Roth IRA are not deductible.
Withdrawals from a traditional IRA
are taxable, while withdrawals from a Roth are tax-free as
long as the account has been open at least five years and
you are age 59 1/2 or older.
At age 70 1/2, you must begin to
take withdrawals from a traditional IRA or face steep
penalties. But with a Roth IRA, you don't have to take
withdrawals at any age, meaning the account can continue to
grow tax-free for decades and be passed on to your heirs
tax-free.
An Option
for High Wage Earners
Let's say
you can't qualify for IRA deductions because you actively
participate in an employer-sponsored retirement plan and your
adjusted gross income exceeds the level
allowed.
Fortunately, highly paid wage earners aren't
completely closed out of the IRA market. Even
if you can't deduct IRA contributions or contribute
to a Roth IRA, you're still permitted to make
nondeductible contributions to a traditional IRA. As with
regular IRA or Roth IRA contributions, the limit for 2006 is
$4,000, plus a "catch-up contribution" of $1,000 if you were
age 50 or older on 12/31/06.
Contributions to a
nondeductible IRA allow you to build up tax-deferred earnings,
just like a regular IRA, until distributions are made. This
allows you to save more for retirement. The portion of your
IRA distributions representing nondeductible contributions is
tax-free.
Important: When making a deductible or
nondeductible contribution, be sure to tell the IRA trustee
that the contribution is for 2006. Otherwise, the trustee may
report it as being for 2007.
Working Teens Can Also Have
IRAs
Did your
children or grandchildren earn some money working last
year? If so, they also have time to make a 2006 IRA
contribution. As you'll see, the IRA contribution strategy is
a terrific idea because the children can potentially
accumulate a truly amazing amount by retirement age.
Specifically, your child can contribute the lesser of
earned income or $4,000 for the 2006 tax year.
Children with earned income have the option of
contributing to either a traditional deductible IRA or a
tax-free Roth IRA. The contribution limits are the same for
both. Having your child contribute to a Roth account is
usually the best alternative, even though it doesn't create a
tax deduction. Why? Your child can later withdraw all or part
of his or her Roth IRA contributions - without any
federal income tax or penalty - to pay for college,
buy a car, put a down payment on a new house or for any other
reason. (However, he or she generally cannot withdraw any Roth
account earnings tax-free before age 59 1/2.)
Of course, even though the child will have the right
to withdraw Roth IRA contributions without any adverse federal
income tax consequences, the best strategy is to leave as much
of the account balance as possible untouched until retirement
age.
Example:
Let's say your
child contributes $1,000 to a Roth account this year. After 45
years, the account would be worth $31,920 assuming an 8
percent annual return. Say your kid contributes another $1,000
next year and lets the money ride. The Roth IRA would be worth
$61,475 after 45 years. As you can see, the numbers really
start adding up. After age 59 1/2, your child can begin taking
federal-income-tax-free withdrawals. In other words, your
child will never owe any federal income tax on the accumulated
Roth IRA earnings. In contrast, if your child contributes to a
traditional deductible IRA, all subsequent withdrawals will be
taxable income. Payouts before age 59 1/2 are also hit
with a 10 percent penalty tax, unless they are used for
certain IRS-approved reasons (including paying for college or
a first home).
Here's
another big reason for the Roth IRA alternative: Your child
may not actually save any taxes by contributing to a
traditional deductible IRA. Why? Because an unmarried
dependent taxpayer's standard deduction amount automatically
shelters up to $5,150 of earned income for 2006 from the
federal income tax. For 2007, the standard deduction increases
to $5,350. Therefore, contributing to a traditional IRA won't
necessarily create any current tax savings unless your
child has a fairly substantial amount of income. So a Roth IRA
is generally the best move.
One more
plus: Owning a Roth IRA
(or a traditional IRA for that matter) generally won't cost
your child any financial aid dollars at college time (at least
not under the current guidelines). This is because the
financial aid calculations generally don't count IRAs as
assets. |