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Money Management (Distributed by the New Jersey Society of Certified Public Accountants)

IRA Options: Choose the Right One For You

Today, Individual Retirement Accounts (IRAs) offer a number of options for saving toward retirement or a college education. According to the New Jersey Society of Certified Public Accountants (NJSCPA), choosing the right one for you and your family is critical to ensuring that you have the finances for your goals. Here is an overview of some of the most popular types of IRAs.

Traditional and Roth IRAs
Anyone with earned income who is under age 701/2 is eligible to open an IRA. Taxpayers may make contributions until April 15, 2002, and qualified individuals contributing to traditional IRAs may claim a deduction on their 2001 returns. However, the tax treatment of your IRA contribution depends on you and your spouse's eligibility to participate in an employer-sponsored plan, filing status and adjusted gross income (AGI). A partial IRA deduction will be available in 2001 to joint filers with AGIs under $63,000 and to single filers with AGIs under $43,000 who are active participants in an employer-sponsored retirement plan. If only one spouse is a participant, the IRA deduction phase-out begins at $150,000 of AGI. Earnings in a traditional IRA are not taxed until you take distributions or until you are required to start making withdrawals at age 701/2.

Contributions to a Roth IRA are not tax-deductible, but all withdrawals of principal and interest are tax-free if you hold your account for at least five years and until you reach age 591/2. Among its other features, the Roth IRA has higher income limits than traditional IRAs. The Roth IRA contribution phases out at $150,000-$160,000 of AGI for joint filers and $95,000-$110,000 for singles and heads of household. With a Roth IRA, you also can continue to contribute after you are 701/2 and can withdraw your money at any age.

The contribution limits are the same for both traditional and Roth IRAs. Under the Tax Act of 2001, the maximum contribution to an IRA, which has been set at $2,000 for the last 20 years, rises gradually from $3,000 in 2002 to $5,000 in 2008. Thereafter, it is indexed for inflation. Individuals age 50 and over have the opportunity to "catch up" by making additional annual IRA contributions to traditional and Roth IRAs ($500 for 2002 to 2005, and $1,000 for 2006 and later).

Deciding Factors
Many factors can impact the type of IRA that is best for you. For high-income taxpayers who don't qualify for a deductible contribution to a traditional IRA, the decision may be easier. But if you're eligible for both, deciding if it's better to take an upfront deduction from a traditional IRA or benefit from tax-free Roth IRA withdrawals later in life is more difficult. Generally, the further you are from retirement, the more attractive a Roth IRA is. That's because the longer your earnings have to grow, the more tax-free income you can potentially earn. Other factors to consider include your tax bracket now, your expected tax bracket in retirement, how long the money will stay in the IRA, and the return you expect from your investments.

EDUCATION IRAs
In addition to traditional and Roth IRAs, taxpayers may qualify for education IRAs. Now called Coverdell Education Savings Accounts, these IRAs are likely to become more popular in 2002 when the annual contribution limit increases to $2,000 for beneficiaries under age 18. The previous limit was $500. And because the new tax law substantially increases the contribution phase-out range for joint filers, more families with higher incomes can take advantage of this college savings tool. Contributions are not deductible, but earnings accumulate tax-free. When money is withdrawn to pay for qualified education expenses, the distributions generally are tax-free as well. Also, the new tax law expands the definition of qualified education expenses to include elementary (including kindergarten) and secondary school expenses as well as college tuition costs.

SIMPLE IRAs
The SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a tax-deferred retirement plan for sole proprietors and small business owners with 100 or fewer employees. SIMPLE IRA contributions are fully deductible and earnings grow tax-deferred until withdrawn at retirement when they are taxed as ordinary income. Small business owners and employees can make tax-deductible contributions of up to $7,000 in 2002. The business owner can structure the plan so that the company either matches the employee's contribution (up to 3 percent of pay) or makes a flat contribution equal to 2 percent of pay for all employees, regardless of whether they contribute. With the exception of the higher contribution limits, SIMPLE IRAs are subject to the same rules as traditional IRAs.

Consult A CPA
Your choices for saving for retirement and for a child's education are now greater than ever. If you're confused about which plan might be best for you, consult with a CPA who can help you select the best alternative for your goals.

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Money Management is a weekly column on personal finance distributed by the NJSCPA.

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