CAN AN IRA BOOST YOUR RETIREMENT PLAN?

In saving for retirement, Americans today have a number of options. In earlier decades, many Americans relied on traditional company pension plans, in some combination with social security, to fund their retirement. However, more and more companies have switched from traditional "defined benefit" pension plans — which ensure a steady stream of income in retirement — to "defined contribution" plans such as 401(k)s, in which employees maintain their own accounts throughout their period of employment, and eventual disbursements are dependent on the vagaries of the market.

And social security, even if it remains fully funded for decades to come, is sufficient for satisfying only a percentage of most retirees’ needs.

In this volatile environment, many Americans are seeking alternative ways of supplementing their retirement savings. One such way is the Individual Retirement Account, or IRA. First offered in 1974 as a tax-advantaged means of saving, IRAs are commonly available in two varieties: a traditional IRA, in which annual contributions are tax-deductible, but eventual withdrawals as taxed as income; and a Roth IRA, in which annual contributions are NOT tax-deductible, but eventual withdrawals have no tax impact — they are tax free. A traditional IRA can be "rolled over," or converted, to a Roth, and under certain circumstances a Roth IRA may be "recharacterized" as a traditional IRA, but investors must follow precise procedures in both cases.

Funds applied to an IRA account can be invested in a broad range of vehicles, but are primarily invested in stock or bond mutual funds, and thus the assets in the account fluctuate with the market. Any capital gains or dividends earned by these funds in the course of a given tax year — through the fund manager’s sale of stocks or bonds in the overall fund — are NOT taxable to the investor; only withdrawals from the account create a taxable event, and for investors in Roth accounts, even withdrawals are tax-free, provided the withdrawals are not made prematurely.

Annual contributions to an IRA account are limited, based on the investor’s income level, and these limits are often adjusted. As of 2010, an individual could invest up to $5,000 in a regular IRA account, provided that that individual has earned at least the amount of his or her contribution as income during that year. (This limit will be inflation adjusted for 2011 and subsequent years.) A new rule introduced in 1997 stipulates that a spouse with no income may also contribute the full amount to his or her own IRA account, provided that family income for the year is at least as much as total IRA contributions by both spouses, and provided that the couple files taxes jointly. And investors aged 50 or older may contribute, annually, an additional $1,000 "catch-up contribution," as an incentive to ramp up savings as one approaches retirement.

As for Roth IRAs, the same $5,000 annual contribution limit applies, as do the allowances for nonworking spouses and catch-up contributions. However, as of 2010, investors who are married and file taxes jointly can only invest in a Roth IRA if their modified adjusted gross income (MAGI) is $177,000 or less; the limit is $120,000 for investors filing taxes singly. Additional restrictions apply if an investor wishes to make a full contribution to a Roth IRA ($5,000, or $6,000 for an investor over the age of 50): joint filers must have a MAGI of less than $167,000 to make full contributions, and a single filer must have a MAGI of less than $105,000. These restrictions are intended to prevent highly compensated individuals from investing in Roth IRAs; high earners, of course, can still invest in traditional IRAs. These limitations are adjusted from year to year.

Investors can begin withdrawing funds from their IRAs at age 59½, and investors in traditional IRAs MUST begin withdrawing when they turn 70. (Roth investors have no withdrawal requirements, and can thus pass on their IRAs to their heirs.) Investors can withdraw funds earlier if they wish, but penalties and taxes may be charged.

Rules for rolling over, or converting, a traditional IRA to a Roth, are fairly complex: basically, tax will be owed on the full amount that is converted, less the original value of any nondeductible contributions that were made to the traditional IRA. However, given that eventual withdrawals from Roth IRAs are tax free, it may be beneficial to roll over, especially for younger investors. Also, under certain circumstances, a Roth that has been "rolled over" from a traditional IRA, may be recharacterized as a traditional IRA, though the rules for this are precise.

Is an IRA investment right for you? If you or your family has additional cash to invest for retirement, the tax benefits of an IRA are hard to beat. Of course, your investment may rise and fall with the market, whether you invest your IRA funds in a mutual fund, a basket of individually picked stocks and bonds, or some other investment vehicle. It would be wiser to target mutual funds that generate substantial dividend and capital gains income for your IRA account — saving low-tax vehicles (such as municipal bonds) for fully taxable accounts.

But it is important to do your research, and consult with a financial advisor if you have an opportunity, to ensure that your IRA investment meets your retirement needs.