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Financial Planning Newsletter• Mar 1 2009 


Financial Planning Newsletter
March 2010

ALL ABOUT IRA'S - part 1

This month we kick off a series on IRA's. We will be covering all the important aspects of this widely held account over the next several months. Some of the topics (notably the Roth) have been covered in previous newsletters, but it is important enough to reiterate multiple times.

Some IRA trivia for you:

Most of us refer to the IRA as an acronym for "Individual Retirement Account", but if you want to get technical the IRS actually refers to the IRA as "Individual Retirement Arrangement".

Direct from the IRS website here is their definition of the IRA:

"An individual retirement arrangement, or IRA, is a personal savings plan which allows you to set aside money for retirement, while offering you tax advantages. You may be able to deduct some or all of your contributions to your IRA. You may also be eligible for a tax credit equal to a percentage of your contribution. Amounts in your IRA, including earnings, generally are not taxed until distributed to you. IRA's cannot be owned jointly. However, any amounts remaining in your IRA upon your death can be paid to your beneficiary or beneficiaries.

To contribute to a traditional IRA, you must be under age 70 1/2 at the end of the tax year. You, and/or your spouse if you file a joint return, must have taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self–employment. Taxable alimony and separate maintenance payments received by an individual are treated as compensation for IRA purposes.

Compensation does not include earnings and profits from property, such as rental income, interest and dividend income or any amount received as pension or annuity income, or as deferred compensation."

IRA Basics and your 401k:

You can't really discuss IRA's without taking a step back and understanding how most IRA's come into existence. For most folks that work for a corporation you have a "qualified" plan that allows you to put away savings for retirement. This plan is generally referred to a 401k (if you want to get technical a qualified plan has to be either a profit share or ESOP - the 401k is the portion that allows employee contributions). If you work for a non-profit or school system your company retirement plan is called a 403b. When you leave your job either through retirement, job change or other reason the retirement money just sits out there until you do something with it. Many opt to establish a "rollover IRA" and transfer the money from the old 401k plan to their own IRA.

A breakdown of IRA's:

Rollover IRA: pretax money from old retirement plans. You code this as "rollover" because this allows you to maintain the ability to move it back to an active 401k if you so choose. There are also asset protection benefits that we won't go into here.

Traditional IRA: can be either pretax or after tax IRA contributions. This is an IRA that you set up to make annual contributions to around tax time. The contribution limit is $5000 this year (if over 50 you can put in $6000). Based on your income you may or may not be able to deduct this contribution. If you contribute to a 401k more than likely you cannot deduct the contribution to a traditional IRA. (more on this next month) Basically the money grows tax deferred and all growth is taxable when you take distributions

Roth IRA: much like a traditional IRA you can contribute to this annually, but only with after-tax money (no tax deduction). The limits are the same in that you can contribute up to $5000 ($6000 if over 50) but there are income caps that limit eligibility. The big difference is that all growth is completely tax free when pulled out in retirement (after age 59 1/2). There are two other possibilities for funding a Roth IRA: Roth Conversion and Roth 401k rollover. In order not to confuse you to much we will have a completely separate newsletter on the Roth Conversion this year.

Just remember that with a Traditional or Roth IRA if you are contemplating contributing and you meet the income restrictions the $5000 annual contribution limit is aggregate of both. This means you cannot put $5k into each type of IRA. It can all go in one, the other or divided between the two.

Lastly, while I could talk on this subject all day I am purposely dividing up the information so that is is easy to understand. The one thing to remember about IRA's is that they are accounts, not unlike your checking or savings account. You can have multiple IRA's. In fact I recommend that most clients keep their "rollover" and "traditional" IRA dollars segregated. So they may in fact have 2 IRA's with the same custodian. In the months to come we will go into advanced topics such as RMD's that will impact this, but for now hopefully you have a baseline knowledge of the IRA.

James A. Daniel,

This newsletter if for informational purposes only. The information contained within should not be considered as financial advice nor soliciation for financial services. Consult with your financial professional if you have any questions.

The Advisory Firm, LLC is a fee-only financial planning company and registered investment advisor.

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