Since the first of the year I have been asked a surprisingly large number of questions about the new IRA rules--questions on eligibility, annual ceilings, withdrawal penalties and perhaps most frequently about the various investment media available.
Rather than try to answer each of the individual questions separately, I thought it might pay to devote the next several columns to an overall view of the IRA program. If I haven't answered your specific question by the time we're through, please write again.
An Individual Retirement Account is a tax-advantaged technique that permits anyone receiving earned income to build his or her own savings plan for retirement.
There are two distinct tax advantages associated with an IRA.
1. The number of dollars you deposit into an IRA (within the annual ceiling) is deducted from your taxable income for the year, so whatever amount you save is not reduced by income tax before investment.
2. The dollars earned by the money invested (and by the retained earnings from prior years) is not subject to current tax, so earnings can compound without reduction for income tax liability.
Notice that I used the words "tax advantaged." That's because the tax on all this money is not forgotten, but only deferred--deferred until you withdraw any of the funds.
At that time presumably you will have retired and will be in a lower tax bracket. So one tax advantage is a shift of tax liability from a high-bracket year to a low-bracket year.
More important, every dollar invested (or re-invested from earnings) is a before-tax dollar, not reduced by any current tax liability. In effect, you have an interest-free loan of the tax money from the date you invest it until you draw it out.
Who is eligible?
Everyone who has earned income is eligible to deposit money into an IRA. It doesn't matter whether you are a salaried employe, a salesman on commission, a self-employed professional.
The butcher, the baker and the candlestick maker can all open IRAs--whether they've been on the job 30 days or 30 years, make $30 a week or $30,000 a year, work for one employer or a dozen.
The Economic Recovery Tax Act of 1981 opened the IRA gates wide. Since Jan. 1, 1982, you are eligible for an IRA even if you're covered by a retirement plan where you work, including both private industry and all levels of government.
If you're self-employed, you can have an IRA in addition to your Keogh plan. And you're eligible for an IRA even if you work for an educational or charitable organization and contribute to a tax-sheltered annuity there.
How much can I invest?
If you work for pay, you can invest into an IRA for each year 100 percent of your earned income up to a maximum of $2,000.
A self-employed person is limited to the amount of net earnings after subtracting expenses as well as any payments into a Keogh plan.
Similarly, one who participates in a tax-sheltered annuity must reduce his earnings by the annuity contribution to arrive at the net amount of earned income to be applied.
But in no case does a reduction have to be made for any Social Security (FICA) tax or income tax withheld from pay.
If you're married and your spouse has earned income, each of you is independently eligible for an IRA, each governed separately by the annual ceilings. So even if you file a joint tax return, if you each earn $2,000 or more you can invest a total of $4,000 a year and deduct the entire amount from your combined income on your tax return.
If you're married and your spouse does not work for pay, then the annual ceiling on contributions goes up to $2,250 (but still is limited to 100 percent of earned income).
To use the full $2,250, you must open two separate IRAs--one for you and one for your spouse. The total for both accounts cannot exceed the given limits, but you can split it in any proportion you want except that you can't put more than $2,000 in any one account.