NEW YORK As the deadline nears for filing income tax
returns, millions of taxpayers must decide whether to open an
Individual Retirement Account for 1999, and if so, which kind.
The decision must be made soon because the deadline for opening
a traditional IRA and getting a deduction of up to $2,000 is April
17, the date that tax returns are due this year. But financial
advisers warn taxpayers to stop and think before rushing out to get
a traditional IRA.
First, you might not be eligible for that deduction. More
important is the fact that the money you save now on taxes might
cost you more in the long term.
"Who cares about that!" certified public accountant Ed Slott
said of the tax savings on a $2,000 deduction.
Traditional IRAs have fallen from grace in the eyes of Slott and
other financial advisers since the advent of the Roth IRA in the
1998. While the traditional IRA gives you money back up front if
your tax rate is 28 percent, you'd get $560 on a $2,000
contribution you'll be paying taxes on every dollar you withdraw.
With the Roth IRA, you can't deduct your contribution, but the
money you withdraw after age 59 1/2 will be tax-free. Chances are,
with compounding of interest or advances in the stock market, your
gain on investments will be much, much more than $560.
But if you feel you really need the tax deduction right now, and
you want a traditional IRA, be sure you're eligible to get a
deduction. Several factors go into determining whether you are,
including whether or not you and/or your spouse were covered by a
retirement plan at work and how much money you and/or your spouse
earned last year.
The rules can get complicated. The instruction booklet with
Internal Revenue Service Form 1040, the individual tax return,
includes a worksheet to help taxpayers determine how much of their
traditional IRA contribution is deductible. Further details are in
the IRS's Publication 590, Individual Retirement Arrangements. It's
available online for those with Adobe Acrobat on their computer at
http://ftp.fedworld.gov/pub/irs-pdf/p590.pdf or by phone at (800)
In one of the simplest cases, if you were single last year and
earned less than $31,000, you can take a full $2,000 deduction even
if you were covered by a retirement plan at work. If you earned
more than $31,000 but less than $41,000, you could get a partial
deduction. At $41,000, there's no deduction.
If you are married and filing a joint return, and both spouses
were covered by retirement plans, you get the full deduction as
long as you jointly earned less than $51,000. If you jointly earned
more than $51,000 but less than $61,000, you get a partial
deduction; at $61,000 there's no deduction.
Another factor is age: You must be younger than age 70 1/2 to open
a traditional IRA (there are no age restrictions for opening a Roth
If you're going to open an IRA and want it credited for the 1999
tax year, you have to have the money in the account by April 17
even if you file for an extension of the filing deadline.
Among the positives for many taxpayers and investors about the
Roth IRA is that it has much higher income limits. You can
contribute the full $2,000 if you earned $110,000 as a single
taxpayer or $160,000 as a couple filing jointly. Above those
amounts, the allowable contribution is reduced according to a
formula contained in Publication 590.
You don't need to report the amount contributed to a Roth IRA,
unless it was part of a conversion from a traditional IRA. In that
case, you'll have to pay tax on the amount converted and file Form
8606 with your return. You need to keep records of all IRA
transactions, taxable or not.
You can open a Roth IRA even if you were covered by a retirement
plan at work. For some taxpayers, that begs the question should
you pay the maximum to a 401(k) plan and then open a Roth IRA, or
contribute as much as possible to the Roth IRA and then contribute
to the 401(k)?
Some advisers say put some money into a Roth IRA simply because
there's no tax to pay down the road. While your 401(k)
contributions are entirely tax-exempt, you'll have to pay tax on
withdrawals in the future.
Slott, who edits the Rockville Center, N.Y.-based newsletter Ed
Slott's IRA Advisor, disagrees, noting that most employers match
part of a worker's contribution.
"That's free money you never want to give that up," he said,
advising taxpayers to contribute the maximum to a 401(k) and "then
go to the Roth IRA if you have money left over."
A last decision that needs to be made is what kind of investment
vehicle: a bank account, brokerage firm or mutual fund family.
If you're a young person, you probably don't want to put your
money into a bank IRA, Slott said. "It's safe, but it won't buy a
cup of coffee in a few years," he said, advising younger people to
buy into mutual funds. If they believe stocks are risky, then they
should choose a conservative fund.
Older IRA contributors, if they're worried about risks, might
sleep more soundly with a high-paying bank certificate of deposit.