Why You Should Fund an IRA in 2008 and 2009

The issues related to funding of an Individual Retirement Account (IRA) are particularly complex for baby boomers for several reasons.  Fear of investing after what happened in 2008 is certainly one of them.  Nevertheless, I think that all baby boomers should give strong consideration to funding an IRA in 2008 and 2009.

IRA Basics

Before I mention some reasons why you should consider IRA funding for both 2008 and 2009, let’s review some IRA basics.

Some boomers are covered by a retirement plan at work and make too much money to be eligible for a traditional IRA.  A traditional IRA (sometimes called a deductible IRA) is one in which your contributions are not taxed going in.  However, when distributions are made from the traditional IRA, everything is taxed at your ordinary income tax rates in effect at the time of withdrawal. 

For 2008, if you are a single taxpayer with adjusted gross income (AGI) in excess of 53,000, the deductibility of contributions begins to phase out and then is lost completely at $63,000 AGI.  For joint filers, those AGI limits are $85,000 and $103,000.  

For 2009, these AGI limits are increased to $55,000 and $65,000 for single filers and to $89,000 and $109,000 for joint filers.

A working or non-working spouse who is not covered by a retirement plan can contribute to a traditional deductible IRA in 2008 if joint AGI is less than $159,000 (full deductibility) and $169,000 (partial deductibility).  These limits are increased to $166,000 and $176,000 for 2009.

The Roth IRA

A Roth IRA differs in several respects from a traditional IRA, the most important being that because the contributions are taxed, all distributions (including investment earnings) are tax-free.  Mr. GoTo thinks that the tax-free distribution feature is extremely important and valuable to baby boomers.  I say this because it is almost certain that marginal income tax rates are going up in the near future.  Tax rates must be increased so that the government can pay for all its recent borrowings, future stimulus packages, and entitlement programs. 

Thus, the primary reason you should consider funding an IRA for 2008 and 2009 is to capture the tax-free distribution benefit of a Roth IRA.  It is possible if not likely that when you retire, your tax rates will be higher than when you were working.

Not everyone is eligible to fund a Roth IRA.  For 2008, the Roth IRA contribution limits apply as follows:

• If you are filing jointly or are a qualifying widow(er), the contribution limits ($6,000 if you are over 50) begins to phase out when your modified AGI exceeds $159,000. You cannot make a Roth IRA contribution if your modified AGI is $169,000 or more.
• If you are single filer, these AGI limits are $101,000 and $116,000.

Note that the AGI limits for a Roth IRA are more favorable than the limits for a traditional IRA.  This is because you are paying taxes on the contributions.

Another significant advantage of a Roth IRA compared to a traditional IRA is that funds in a Roth IRA are not subject to Required Minimum Distribution rules.  You can withdraw or not withdraw based on your own needs, not when the IRS tells you!  This can be helpful if you determine that you want to pass the Roth IRA on to your heirs.

The Non-Deductible IRA

If you are not eligible now to fund a traditional or Roth IRA, you can still fund a non-deductible IRA.  With this type of IRA, your contributions are taxed and the investment earnings portion of your withdrawals are taxed.   But now there is an even bigger reason to fund even a non-deductible IRA for 2008 and 2009.

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) allows taxpayers to convert existing IRA’s (traditional or non-deductible) to a Roth IRA without regard to AGI!  This window of opportunity opens in 2010.  Of course, if you have a traditional IRA, you will have to pay taxes on contributions and earnings at the time of the conversion but those taxes can be spread out over 2011 and 2012.  If you convert from a non-deductible IRA, you will have to pay taxes on the earnings at that time, again spread over two years.

If you agree with me that tax rates are going up, or if you want to have a source of tax-free income available to you in retirement to better manage your tax obligations, then you should definitely take advantage of this 2010 Roth conversion opportunity.  Being able to manage your taxable retirement income can also help you minimize taxation of your Social Security benefits as well.

Keep in mind that you can contribute to an IRA for 2008 at any time prior to filing your 2008 tax return.  If you are married and both of you are over-50, this will allow you to contribute $12,000 for 2008, $12,000 for 2009 and $12,000 for 2010, in addition to any prior IRA funds that you have.  From then on, everything grows and is paid out tax free.

So, think about funding an IRA for 2008 and 2009, ignoring your fear of current market conditions.  With the Roth conversion opportunity and increased tax rates on the horizon, you will very likely come out way ahead.

Photo credit:  Vangelis Thomaidis

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