Topic: Individual Retirement Account (IRA)
There are five types of IRAs available.
The traditional IRA, Roth IRA, SEP IRA, SIMPLE
IRA, and Education IRA. We are going to focus on
the Traditional, Roth and Educational IRA.
An IRA is type of investment account that allows
the holder to invest (contribute) their money so
that it will grow tax-free or tax-deferred, untouched,
until they retire.
The concept of tax-free growth is very appealing
to many investors. Primarily, because it allows them
to have more money working for them each year.
This is n contrast to a savings or investment account,
in which the capital gains are taxed.
As an example, if a 20-year old who were to invest $3,000
a year (total cash investment: $130,000) into a Roth IRA
until they retire (age 65) and they were to receive a 7.5%
average annual return, they would have an ending balance
of $1,070,908.
In contrast, the same $3,000 yearly invest in a non-tax sheltered
account with a 7.5% average annual return will return less
than $130,000. This amount was figured using an average tax rate
of 27% for federal, 8% for state tax and 4% inflation rate.
To run a similar calculation for yourself, you can use the Java
Financial Calculators by clicking on the links below:
http://www.dinkytown.net/java/RothIRA.html
Money placed in IRA accounts are generally invested
in mutual funds or money market accounts. Intermediate
and advanced investors will "self direct" their money by
choosing individual stocks to invest in as opposed to
purchasing mutual funds.
Depending upon the type of IRA, you pay taxes either
when you put the money in (Roth) or when you take it
out (Traditional).
Maximum IRA (Traditional / Roth) Contributions
allowed by year.
|
2002 |
$3,000 |
|
2003 |
$3,000 |
|
2004 |
$3,000 |
|
2005 |
$4,000 |
|
2006 |
$4,000 |
|
2007 |
$4,000 |
|
2008 |
$5,000 |
IRA Facts - Non-Working Spouse
Contributions for a non-working spouse can be
made into either a Traditional or Roth IRA.
Rollovers
When a person leaves a job, they generally must take
their saved retirement monies with them. They
would "rollover" their retirement money to the new
company's qualified retirement plan or roll it over
into a new or established IRA.
No money is lost in the process.
Rollover Facts
TRADITIONAL IRA
A traditional IRA is one that allows an investor to
make pre-tax contributions. Taxes must be paid on the money
when it is distributed. Taxes will be determined by using
the investors current tax rate.
In 2002 and beyond, the contribution limits were raised. An
investor can contribute up to $3,000 per year into a traditional
IRA. Also, if you are over 50 years of age, you can make
"catch-up" payments of $500 more than the normal contribution
limits through the year 2006. You must turn 50 by the end of the
year in which you are making the contribution.
IRA contributions are not always deductible. If you are
eligible for a qualified retirement plan from your
employer (i.e. 401(k), 403(b)); or, if your modified adjusted
gross income is greater than $64,000 (married filling jointly) or
$44,000 (single head of household), you may not be eligible
for this deduction.
For specific information regarding your personal situation,
be sure to seek professional help from a tax-advisor.
ROTH IRA
Similar to a traditional IRA, the ROTH IRA earnings grow
tax-free, but unlike the traditional, will remain tax-free on
distribution. All contributions to Roth IRAs are after-tax
monies and are NOT tax deductible.
Many investors have found the ROTH IRA more
appealing than the traditional IRA, due to the
tax-free distribution rule.
To be eligible to contribute, your Adjusted Gross
Income must be below $95,000 for singles and
$150,000 for married couples.
EDUCATION IRA
Contributions of $500 (after tax money) per year
per child under 18 can be made. The money grows
tax-free if used for college education. This
money can be used to pay college expenses, such
as books and tuition.
IRA's are available from every major brokerage firm,
mutual fund company, bank and credit union. Be
sure to evaluate all the available investment options
for you. An IRA may be opened with as little as $50.
Comparisons
Goal:
To teach your children how to compare and
contrast financial investment vehicles.
Tools Used:
Internet
Financial Calculators
Skills exercised:
Mathematical Calculations
Research
Problem solving
Step 1.
Explain to your child the concept of the IRA
and the benefits of tax-free growth vs. keeping
their retirement money in a savings account.
Step 2.
Have your child compare and contrast the amount
of money they will have saved for their retirement,
by using a simple savings account, a ROTH IRA
and a traditional IRA.
To do this, have them start with a $0 balance and a
planned contribution of $250 a month into each account.
Use a similar percentage rate for the IRAs (7.5%) and
4.0 % in a savings account (assuming the purchase of CDs).
When using a savings account, you must factor in tax and
inflation.
Complete two exercises, the first starting at age 20 and
contribute until age 65. The second, starting at age 35 and
contribute until age 65.
Step 3.
Use the free financial calculators on the Internet to assist in
finding the answers.
We use the Java Financial Calculators. You can do so also
by clicking on the link:
http://www.dinkytown.net/java/RothIRA.html
Step 4.
Have your child explain which is a better financial
investment based on their research and why?
Why it is important to start investing at an early age.
********************
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Enjoy the rest of your week
Timothy Liptrap
Vice President, 101 Financial Lessons
http://www.101financiallessons.com
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