A Stalwart of Retirement Planning: The I.R.A.
by J. Alex Tarquinio
Thursday, May 29, 2008
provided by nytimes.com


With so much contradictory advice floating around, it is sometimes hard to figure out the best way to save for retirement.

Financial experts say that one often-overlooked resource is the humble Individual Retirement Account, or I.R.A., which has been a part of the personal finance landscape for so long that many of us take it for granted.

More than 90 percent of the money that flows into traditional I.R.A.’s is being rolled over from retirement plans at work, like 401(k)’s. On the other hand, only 14 percent of American households that were eligible to make direct I.R.A. contributions did so in 2006, according to the most recent data from the Investment Company Institute, the mutual fund industry trade group.

The rules for some I.R.A. contributions are so complex that many Americans may not realize they are eligible to make them, said Brian Reid, the chief economist at the Investment Company Institute. Indeed, the I.R.A. rules fill a 108-page brochure on the Web site.

And while investors often fund a 401(k) at work before contributing to an I.R.A., particularly if employers offer matching contributions, many people don’t have a 401(k) or other workplace option. Alicia H. Munnell, director of the Center for Retirement Research at Boston College, said that 57 percent of “prime working-age Americans,” defined as 25 to 64 years old, had no retirement plan at work. Contributing to an I.R.A. makes sense for such people, she said.

In a nutshell, the main flavors of I.R.A. — traditional and Roth — have one big difference. You may be able to deduct the money you put into a traditional I.R.A. on your taxes, but you will pay income taxes on all withdrawals in retirement. Contributions to Roth I.R.A.’s are not deductible up front, but there are no taxes on money withdrawn in retirement.

Some I.R.A. rules are simple. Say you are single, do not have a retirement plan at work — like a 401(k) or a traditional pension — and want to contribute to a traditional I.R.A. Whatever your income, you can make the maximum contribution, all of it deductible. (The maximum total contribution for all I.R.A.’s is $5,000 this year, or $6,000 if you are 50 and above.)

But the rules can quickly become more convoluted. If you are single but eligible for a retirement plan at work, you may make the maximum tax-deductible contribution so long as your adjusted gross income is $53,000 or less. The deductible amount whittles away to zero as your income climbs from $53,000 to $63,000.

If you are married and filing taxes jointly, and both of your employers offer retirement plans, both of you can make the maximum deductible contribution so long as adjusted gross household income doesn’t exceed $85,000. The deductible amount phases out at higher incomes, falling to zero at $105,000. And the list goes on.

If you’re considering a Roth I.R.A., it doesn’t matter if you have an employer plan at work. But a single person, for example, can make the full contribution only if income is less than $101,000. The eligible contribution phases out as income climbs to $116,000.

The government slapped income limits on I.R.A.’s in the 1980s to prevent high-income taxpayers from redirecting savings to tax-deferred accounts, said Ms. Munnell at the Center for Retirement Research. “A lot of evidence suggested that higher-income people were simply rearranging their finances,” she said.

A third form of I.R.A., the traditional nondeductible version, is less popular. There are no income limits, and it does not matter whether you have a retirement plan at work. Contributions are not deductible, and you will pay income taxes on investment profits withdrawn in retirement.

Gary Schatsky, a financial planner in New York, said the nondeductible I.R.A. was not compelling for most investors. As is the case with all I.R.A.’s, you cannot write off investment losses on your taxes, and you lose the benefit of capital gains tax rates, which are generally lower than income tax rates. If you are eligible to contribute to either a 401(k) or an I.R.A., Mr. Schatsky said, in most cases you are better off choosing the 401(k), especially if your employer offers matching contributions.

Statistically, few people take full advantage of 401(k)’s. Roughly three of four qualified workers participate, but among those who do, only 10 percent contribute the maximum, according to the Center for Retirement Research.

Labor Department rules issued last fall make it easier for companies to automatically enroll workers in 401(k) plans. Now there is talk in Washington about making enrollment in I.R.A.’s automatic for workers who don’t have 401(k)’s, said James Poterba, the head of the economics department at the Massachusetts Institute of Technology.

Mr. Poterba, who is to become president of the National Bureau of Economic Research this summer, said the issues were more complex for automatic I.R.A. enrollment. For instance, he said, employers choose default investments for the 401(k), but he asked, “Who picks the default investment for an I.R.A.?”

While these issues are being worked out, people without employer plans would benefit by opening I.R.A.’s on their own, Ms. Munnell said, adding that they should find motivation in projected shortfalls for the Social Security trust fund.

The government has already been raising the age when most Social Security applicants can retire at full benefits. For those born from 1938 to 1943, full retirement age rose gradually from 65 to 66. It stays at 66 for those born through 1954, and gradually climbs again, to 67, for those born in 1960 or later.

“Those are the changes that are already baked into the cake,” Ms. Munnell said. If the Social Security projections worsen, she said, future retirees may regret not having saved more.