The first quarter of the year is a great time to open an IRA because you can jump-start your savings with contributions for this year and last year. You just need to have earned income and be younger than 70 1/2 years of age.
Another great reason to open an IRA is to rescue that 401(k) retirement plan account you left behind with a previous employer. A self-directed IRA can offer many more investment opportunities than most 401(k) plans.
For contributions, you have until April 15, 2008 for a 2007 contribution and any time after the first of the year for this year’s contribution.
For 2007, you can contribute up to $4,000; if you are 50 years old or older, your limit is $5,000. For a 2008, the contribution limits are $5,000 and $6,000 for those 50 years old or older.
What exactly is an IRA? It is simply an investment account with special tax privileges that may hold different investment assets stocks, bonds, mutual funds, and in some cases real estate.
IRAs are a great way to save because all tax on the investment earnings, capital gains and income from bonds or certificates of deposit, is deferred until you take your money out of the IRA as retirement income.
Because of this special tax status, an IRA is an account that cannot be shared there are no “joint” IRA accounts – and when you name a beneficiary to inherit your IRA it overrides instructions that are part of your last will and testament.
Because of the power of the IRA beneficiary designation you should take care naming your beneficiary. You can name a single person or you can provide for a percentage of the IRA to a number of different people. You will need the beneficiary’s Social Security Number to complete the form.
You can also name a trust as beneficiary, but special rules apply to distributions to a trust; consult your tax adviser.
You can open an IRA account with any IRA Trustee a bank, a mutual fund company or brokerage firm. The Trustee is simply in charge of maintaining custody of your account including not letting you spend the money until you reach 59 1/2 and filing reports with the IRS.
If you do withdraw funds before 59 1/2 you will pay a 10% penalty on your income tax on the amount withdrawn; however, you may withdraw the current year’s contribution before the tax filing due date if you didn’t take a deduction for the contribution and any earnings on the contribution are withdrawn as well.
The principal difference among IRA trustees is their willingness to hold different investment vehicles. For example, the only permissible investment in an IRA at a mutual fund company will be the mutual funds sponsored by that company.
A bank will permit a greater variety of funds, but most banks only offer load funds you will pay a commission to the registered representative who sets up the account for you at the bank. If you decide to exchange funds in your IRA, you will pay another commission if you switch between different fund families. If you are an active investor, this can be expensive.
The greatest flexibility in investment assets will be offered by an IRA set up with a brokerage firm. There are two kinds of firms: Full Service and Discount. At a full service firm, you’ll be assigned to a stock broker and your account will be able to hold any asset that the firm permits although certain limitations apply to IRAs, for example, for options, only covered calls are permitted.
A discount or on-line broker will offer the same kind of flexibility with lower fees but you will be making all your investment decisions on your own. Some discount brokers give you the opportunity to work with a broker, but different fees may apply.
So in setting up an IRA, you should first consider how sophisticated an investor you are. If you are a buy-and-hold investor, then a single mutual fund family may be more than adequate as your IRA trustee. If you will want to invest your IRA in stocks or exchange traded funds, then you will need to set up a brokerage account. Then you must decide if you want to pay to have someone to talk to about your investing or not.
If you are setting up an IRA to hold a transfer from another IRA or an employer-sponsored retirement plan, a time limit will apply if the other IRA trustee or retirement plan sends you the check. In this case, the check will be made out to you and your IRA trustee. You have 60 days after you receive the check to deposit it with your IRA trustee. (This means you can temporarily “borrow” from your own IRA if you re-deposit the funds within 60 days. Technically, loans from an IRA are not permitted.)
In some cases, however, the other IRA or retirement plan will make a trustee-to-trustee transfer, in which case the 60-day time limit will not apply.
Your final consideration before setting up a traditional IRA is tax deductibility. Depending on your income, you may be able to deduct your contribution to your account from your income tax. Deductibility depends first on whether or not you participate in an employer-sponsored retirement plan. If you do, limitations apply. If you don’t, or, if you’re married and neither you nor your spouse are active participants in an employer retirement plan, then you can deduct your IRA contribution regardless of how much money you made in the tax year.