For Many, Contributing
To an IRA Makes Sense
By Albert B. Crenshaw
(c) The Washington Post
Sunday, April 2, 1995; Page H01
Since the enactment of the Tax Reform Act of 1986 and subsequent "loophole closings" of the late
1980s and early 1990s, many of the nation's favorite tax breaks are gone but not forgotten.
On the other hand, there is one break that seems to be forgotten but not gone: the individual
retirement account, or IRA.
True, the benefits of IRAs have been curtailed. Well-heeled taxpayers who are covered by an
employer-sponsored pension plan -- their own or their spouse's -- cannot deduct IRA
contributions.
But experts say a great many people who could still deduct their contributions are dismissing the
idea. And, they add, even if a person cannot deduct the contribution, the deferral of taxes on the
account's earnings makes a big difference over the years.
"You can end up with 50 percent more" when you invest tax-deferred than you would on the same
investment if you paid current taxes, said Elissa Buie of Financial Planning Group in Falls Church.
Plainly, tax-deductibility was a major force in the IRA market. Contributions plunged after
deductions were restricted in 1986. But now, interest in IRAs, even nondeductible ones, is
growing, in part because of the higher tax brackets now in place, several financial planners and
investment advisers said.
"People are becoming very, very conscious of their tax liabilities," said William G. Brennan, a
financial planner here. "I still have people say, It's only $2,000 and it's more trouble than it's
worth,' {but} with the tax-deferred buildup year after year it can be a substantial amount of money
in a short amount of time."
Since you can make an IRA contribution anytime until you file your return -- or this year's April 17
deadline, whichever comes first -- you may still have time to check if you qualify for a deduction
or, if you don't, whether you want to contribute anyway.
First, look at the deduction requirements.
For married couples, if neither you nor your spouse is covered by a retirement plan at work, then
you can contribute and deduct as much as $2,000 each if you both work and each earned at least
$2,000. If only one of you works, you can contribute and deduct a total of $2,250 between you.
If either of you is covered by a pension plan at work, your contribution is still fully deductible if
your income is $40,000 or less for a married couple, or $25,000 for a single taxpayer. If your
income is between $40,000 and $50,000, or between $25,000 and $35,000 for a single taxpayer,
you are eligible for a partial deduction.
These numbers are not simply the sum of your salaries. They refer to something called modified
adjusted gross income. That's your pay and other taxable income minus certain adjustments, such
as moving expenses, and plus other adjustments, such as deferred interest on U.S. Savings Bonds.
If your income is around the threshold, read the instructions in your tax packet carefully.
To calculate your modified AGI, you have to take your adjusted gross income -- the amount on
line 31 of your 1040 or on line 14 of a 1040A -- and add back any savings bond interest, foreign
earned income or foreign housing exclusion.
If it is over the threshold for full deductibility but not over the limit for any deduction, you will have
to turn to the worksheet that is included in Form 1040 and 1040A instructions to figure out how
much you can take.
Since the median income for married couples nationwide is around $43,000, the limits will
eliminate some or all of the deduction for a lot of people. Median family income in this area is even
higher -- more than $50,000 for the area and more than $60,000 in some suburban counties.
But don't give up. If you are self-employed or have self-employment income, you may be eligible
for a Simplified Employee Pension-IRA or a Keogh plan. Both of these allow generous
tax-deductible contributions and are well worth doing if you are eligible; note, though, that a
Keogh has to be set up before the end of the year, so you can't start one for 1994 at this point.
For more information, get IRS Publication 560, "Retirement Plans for the Self-Employed."
But even if you can't deduct anything, don't simply dismiss the idea of contributing.
The fact that you don't pay taxes on an IRA until you withdraw it allows earnings in one of these
accounts to grow much more rapidly than would if it were taxed currently.
Almost any investment can be included in an IRA, and the deferral of taxes allows the account
holder to choose without worrying about the impact on current taxes. Some holders opt to use
their IRAs for items such as junk bonds that pay high current income or for stocks that they want
to be able to trade without losing a big chunk of their profits to tax every time.
"It liberates you with regard to investment decisions," said Buie. "You have the freedom to buy and
sell as you will" without worrying about the tax consequences.
This feature, along with the growing interest in retirement planning by an aging population, seems to
be breathing new life into the IRA, several planners said.
"I am seeing more people putting in nondeductible contributions than in earlier years," said Barbara
L. Tymec of Tymec Freshwater Consultants in Alexandria. In addition to the flexibility, "maybe
people have gotten over the shock of losing their deduction."
There are disadvantages to IRAs, and they should be weighed carefully before starting one or
adding to your contributions.
First, the money is difficult, though not impossible, to withdraw before age 59 1/2 without incurring
a 10 percent penalty as well as all the regular income taxes you would owe.
Second, you do have to pay taxes on the money when you withdraw it. The assumption is that you
will be in a lower bracket after retirement, but that isn't necessarily so.
In fact, if Congress adds
any more brackets at the top income levels, the reverse could be true.
Finally, the record-keeping requirements are burdensome. Nondeductible contributions are not
taxed again at withdrawal, but you need records to show what was deductible, what was
nondeductible and what were tax-deferred earnings.
Help -- or further complications -- may be on the way. Congressional Republicans are pushing a
liberalized version of the IRA. Contributions would be nondeductible but there would be no tax on
earnings at withdrawal, and conditions for withdrawals would be eased.
