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(June 15, 2006)
This week concludes my highlight on the new tax laws passed by Congress last month. Next up to bat in this column is the Individual Retirement Account - "IRA." Let's review the basics before we get into the tax law change.
Think of an IRA as a bank account, except the money you put into it
grows tax free, and then when you look up, "Tadow" you're rich (or at
least maybe comfortable). Derek Butler, a Partner at Creative Financial Group in Los Angeles explains, "With an IRA the tax is deferred and you pay nothing until you take the money out [typically around retirement age]; so the financial growth in the account is compounding at a faster rate versus other investments like CD's or savings account. With those investments you pay taxes on the growth at the end of every year." But keep in mind, if you take the money out before retirement age, you could be subject to penalties.
Pretty much, "Everybody, Everybody (Black Box, 1990)," can set up an IRA, and in many cases for as little as $250, according to Butler. There are two "Flava's…" (Craig Mack, 1994) of IRAs - the Traditional IRA and Roth IRA. Also, you can contribute up to $4,000 with either IRA.
So what's the major difference between the two types of IRA's? Taxes. With a Traditional IRA, you get a tax deduction immediately when you put the money in. You have to keep the money in the account, or risk having to pay penalties. You can start taking the money out when you are 59 ½ and this is when you pay taxes. But for all those years, you made money in your account and those gains were tax free.
The Roth IRA has the opposite effect. You don't get a tax deduction when you make your contributions. Thus, you make them with after-tax dollars, since you can't take a deduction for them on your tax return. But when you start taking the money out at age 59 1/2, you don't have to pay any taxes. This allows you to make money on an initial contribution without ever having to pay taxes. But you must keep the money in the Roth IRA for at least 5 years, or be subject to penalty taxes.
Which plan is better – The Traditional IRA or the Roth IRA? This question is sort of like asking which version of "Car Wash," do you prefer - the 1977 version by Rose Royce, or the 2004 version by Christina Aguilera? There is no right answer but then again the answer will depend heavily on your personal facts. Some years it may
be better for you to take the Traditional IRA deduction, while in others the Roth IRA might be right. Know the rules, talk to your tax advisor and celebrate, because either way you're building your retirement nest egg.
"Keep in mind," says Butler, "You know what the tax rates are today, but no one knows what the tax rate will be, or for that matter what tax bracket you will be in, when you retire. The bottom line is that you can pay the known tax now or you can pay the unknown tax later."
Of course this wouldn't be a For the Love Of Money style article, if there weren't a few exceptions to keep in mind. If you participate in a 401(k) (or any other employer-sponsored retirement plan), you may not be able to take the deduction for your IRA contribution.
Also, for certain Big Ballers and Shot-Callers, you can't make a contribution to a Roth IRA if your adjusted gross income is more than $160,000, for married couples filing jointly and $110,000 for single folks. These folks can only contribute to a Traditional IRA, which means they won't get a tax deduction.
So why do Ballers still set-up Traditional IRAs? Because even though they get no upfront tax deduction, the money in their Traditional IRA grows tax free and they only pay a tax when they take it out.
But Congress has come to save the day for the Big Ballers and Shot Callers. Thanks to the Tax Increase Prevention and Reconciliation Act, passed on May 11, 2006, high-income taxpayers (those who make over $100,000) will get a one-time opportunity to convert, (known as a rollover), their traditional IRA into a Roth IRA in 2010. Now they too can get the best of both worlds; the money grows tax free and they don't pay a tax when they take it out upon retirement.
How will this work? They will have to rollover their Traditional IRA into a Roth IRA in 2010. The will pay a tax at that time. Then they push the "I Believe" button, and hope that tax rates will stay the same or go up. If that's the case, then by the time they take the money out at age 59 ½ their nest egg will have grown tax free and they
can take the money out tax free. Rewind! They pay a tax in 2010 and that's it! No more taxes on that money. "Outstanding" (Gap Band, 1982).
Some commentators estimate that a Roth rollover could double or triple the amount of your retirement funds. Don't believe me? Try these free on-line Roth conversion calculators:
Creative Financial Group - http://www.creativefinancialgroup.net
MSN Money - http://moneycentral.msn.com/investor/calcs/n_roth/main.asp
Recap: With the Traditional IRA you are using pre-tax dollars to make money and then pay the tax years later. With the Roth IRA, you are using after-tax dollars to, again, make money, but pay no taxes later. If you take money from a Traditional IRA and roll it over into a Roth IRA, you will have to pay an initial tax. Why? Because Roth IRAs can only be set up with money that has been taxed. It may be worth it to
pay this tax now to avoid having to pay a tax at your retirement. In the past, Big Ballers and Shot-Callers were only able to use a Traditional IRA, but new tax laws allow them to use a Roth IRA in 2010; they have four years to "Get It Together," (India Arie, 2002). The bottom line - we all (whether a Baller now or you plan to be one in four years) need to get it together and not let this tax break keep
"Passin" us by (Pharcyde, 1993).
Shannon King Nash is the author of the award-winning book entitled, "For the Love of Money: The 411 to Taking Control of Your Taxes and Building Your Net Worth." She uses song lyrics and entertaining stories ripped from the headlines to teach readers how to manage their finances and taxes. Shannon is a CPA, Tax Attorney, and regular expert commentator on KJLH FM Radio in Los Angeles, and has appeared on national television. She is the CEO of Nash Management Group, a tax and nonprofit consulting firm based in Los Angeles, and a tax partner with the law firm of Guydon Love, based in the Washington DC area. To learn more about Shannon King Nash and "For the Love of Money" visit www.nashgroup-usa.com.
Think of an IRA as a bank account, except the money you put into it
grows tax free, and then when you look up, "Tadow" you're rich (or at
least maybe comfortable). Derek Butler, a Partner at Creative Financial Group in Los Angeles explains, "With an IRA the tax is deferred and you pay nothing until you take the money out [typically around retirement age]; so the financial growth in the account is compounding at a faster rate versus other investments like CD's or savings account. With those investments you pay taxes on the growth at the end of every year." But keep in mind, if you take the money out before retirement age, you could be subject to penalties.
Pretty much, "Everybody, Everybody (Black Box, 1990)," can set up an IRA, and in many cases for as little as $250, according to Butler. There are two "Flava's…" (Craig Mack, 1994) of IRAs - the Traditional IRA and Roth IRA. Also, you can contribute up to $4,000 with either IRA.
So what's the major difference between the two types of IRA's? Taxes. With a Traditional IRA, you get a tax deduction immediately when you put the money in. You have to keep the money in the account, or risk having to pay penalties. You can start taking the money out when you are 59 ½ and this is when you pay taxes. But for all those years, you made money in your account and those gains were tax free.
The Roth IRA has the opposite effect. You don't get a tax deduction when you make your contributions. Thus, you make them with after-tax dollars, since you can't take a deduction for them on your tax return. But when you start taking the money out at age 59 1/2, you don't have to pay any taxes. This allows you to make money on an initial contribution without ever having to pay taxes. But you must keep the money in the Roth IRA for at least 5 years, or be subject to penalty taxes.
Which plan is better – The Traditional IRA or the Roth IRA? This question is sort of like asking which version of "Car Wash," do you prefer - the 1977 version by Rose Royce, or the 2004 version by Christina Aguilera? There is no right answer but then again the answer will depend heavily on your personal facts. Some years it may
be better for you to take the Traditional IRA deduction, while in others the Roth IRA might be right. Know the rules, talk to your tax advisor and celebrate, because either way you're building your retirement nest egg.
"Keep in mind," says Butler, "You know what the tax rates are today, but no one knows what the tax rate will be, or for that matter what tax bracket you will be in, when you retire. The bottom line is that you can pay the known tax now or you can pay the unknown tax later."
Of course this wouldn't be a For the Love Of Money style article, if there weren't a few exceptions to keep in mind. If you participate in a 401(k) (or any other employer-sponsored retirement plan), you may not be able to take the deduction for your IRA contribution.
Also, for certain Big Ballers and Shot-Callers, you can't make a contribution to a Roth IRA if your adjusted gross income is more than $160,000, for married couples filing jointly and $110,000 for single folks. These folks can only contribute to a Traditional IRA, which means they won't get a tax deduction.
So why do Ballers still set-up Traditional IRAs? Because even though they get no upfront tax deduction, the money in their Traditional IRA grows tax free and they only pay a tax when they take it out.
But Congress has come to save the day for the Big Ballers and Shot Callers. Thanks to the Tax Increase Prevention and Reconciliation Act, passed on May 11, 2006, high-income taxpayers (those who make over $100,000) will get a one-time opportunity to convert, (known as a rollover), their traditional IRA into a Roth IRA in 2010. Now they too can get the best of both worlds; the money grows tax free and they don't pay a tax when they take it out upon retirement.
How will this work? They will have to rollover their Traditional IRA into a Roth IRA in 2010. The will pay a tax at that time. Then they push the "I Believe" button, and hope that tax rates will stay the same or go up. If that's the case, then by the time they take the money out at age 59 ½ their nest egg will have grown tax free and they
can take the money out tax free. Rewind! They pay a tax in 2010 and that's it! No more taxes on that money. "Outstanding" (Gap Band, 1982).
Some commentators estimate that a Roth rollover could double or triple the amount of your retirement funds. Don't believe me? Try these free on-line Roth conversion calculators:
Creative Financial Group - http://www.creativefinancialgroup.net
MSN Money - http://moneycentral.msn.com/investor/calcs/n_roth/main.asp
Recap: With the Traditional IRA you are using pre-tax dollars to make money and then pay the tax years later. With the Roth IRA, you are using after-tax dollars to, again, make money, but pay no taxes later. If you take money from a Traditional IRA and roll it over into a Roth IRA, you will have to pay an initial tax. Why? Because Roth IRAs can only be set up with money that has been taxed. It may be worth it to
pay this tax now to avoid having to pay a tax at your retirement. In the past, Big Ballers and Shot-Callers were only able to use a Traditional IRA, but new tax laws allow them to use a Roth IRA in 2010; they have four years to "Get It Together," (India Arie, 2002). The bottom line - we all (whether a Baller now or you plan to be one in four years) need to get it together and not let this tax break keep
"Passin" us by (Pharcyde, 1993).
Shannon King Nash is the author of the award-winning book entitled, "For the Love of Money: The 411 to Taking Control of Your Taxes and Building Your Net Worth." She uses song lyrics and entertaining stories ripped from the headlines to teach readers how to manage their finances and taxes. Shannon is a CPA, Tax Attorney, and regular expert commentator on KJLH FM Radio in Los Angeles, and has appeared on national television. She is the CEO of Nash Management Group, a tax and nonprofit consulting firm based in Los Angeles, and a tax partner with the law firm of Guydon Love, based in the Washington DC area. To learn more about Shannon King Nash and "For the Love of Money" visit www.nashgroup-usa.com.
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