When you contribute to a traditional IRA you don't always get a tax benefit. Find out when you should contribute to both a 401(k) and an IRA and when you shouldn't. http://j.mp/MoneyBooks
Money Girl
216 MG When Is It Bad to Contribute to an IRA?
Hey Fidelity. How can I remember to invest every month? With the Fidelity app, you can choose a schedule and set up recurring investments in stocks and ETFs. Oh, that sounds easier than I thought. You got this. Yeah, I do. Now, where did I put my keys? You will find them. Where you left them. Investing involves risk, including risk of loss, Fidelity brokerage services LLC member NYSE SIPC. Imagine earning a degree that prepares you with real skills for the real world. Capella University's programs teach skills relevant to your career so you can apply what you learn right away. Learn how Capella can make a difference in your life at Capella.edu. Hello and welcome back to the Money Girl podcast. I'm Laura Adams, the author of Money Girl Smart Moves to Grow Rich. If you're like Bonnie, who emailed me a great question about retirement accounts, you might wonder if you should contribute to both a retirement plan at work and an IRA. Here's Bonnie's question. Right now, I'm contributing 10% to my 401k at work, and I'm fortunate that my employer matches half of what I put in up to 6% of my salary. So that means I get an additional 3% from my company for a total contribution of 13%. My goal this year is to contribute 20% of my income or $8,000 for retirement. Should I just increase my 401k contributions or is it better to leave the 401k alone and open up an IRA and contribute the difference of 7% to it instead? Bonnie's question about whether to have both a 401k and an IRA is an important one because there is a little twist in the rules that can make contributing to an employer retirement plan and an IRA in the same year, not such a good idea for some people. In this podcast, we'll look at when it's a smart move to contribute to both and when it isn't. If you are a regular money girl listener, you already know that an IRA stands for Individual Retirement Arrangement, and it's a special type of account you can use to save for retirement that offers money saving tax benefits. In general, investing through a tax-advantaged account is a smart move because it really stretches your dollar. So, for you to understand why I'd ever say that contributing to an IRA could be a bad idea, you need to understand the special rule that I mentioned. Here's the deal. If you or your spouse were covered by an employer retirement plan and you also contribute to an IRA, the tax deduction you get for your IRA contributions may be limited. That's the government's way of making sure you don't get too much of a good tax thing. Let me back up and say that this limitation on deductions only applies to having both a retirement plan at work and a traditional IRA, not a Roth IRA. You get an upfront tax deduction for contributions you make to a traditional IRA, but you don't with a Roth. You always have to pay tax on Roth contributions up front, and all the tax goodness comes in the future when you take tax-free withdrawals during retirement. So, let's talk about the limitation on traditional IRA deductions if you're covered by an employer retirement plan. The deduction you get depends on how much you earn and on your tax filing status. The deduction begins to decrease or what they call "phase out" when your income is above a certain amount and it gets completely eliminated when your income reaches a higher amount. So, you might be entitled to a full deduction, a partial deduction, or no deduction. Here are the allowable IRA deductions for each tax filing status for 2011. If you file as single or head of household, your phase out range is from 56,000 to 66,000. That means if your modified adjusted gross income or magi is $56,000 or less, you get to take a full IRA deduction when you're covered by a retirement plan at work. If your income falls somewhere in between 56 and 66,000, you get to take a partial deduction. But if your magi is $66,000 or more, you're at a luck and get no tax deduction for traditional IRA contributions. If you file taxes as married filing jointly or a qualifying widow or widower, your phase out range is from 90 to $110,000. So, if you have modified adjusted gross income of $90,000 or less, you get to take a full IRA deduction when you're covered by a retirement plan at work. If your income is in between 90 and 110,000, you're entitled to a partial deduction, and if it's 110,000 or more, you get no deduction. If you're married filing separately, when your magi is less than $10,000, you're entitled to a partial deduction, and if it's over 10,000, you get no deduction. Now, in addition to these income limitations, there's one more rule to know that applies to married folks who file a joint return. If you're not covered by a retirement plan at work, but your spouse is, the amount you can deduct is also limited. As a couple, your phase out range for 2011 is $169,000 to $179,000. In other words, if your spouse has an employer retirement plan and your total magi is $179,000 or more, you cannot take a deduction for a contribution to a traditional IRA, even if you don't have a retirement plan at work. We could try to explain what it's like to get your work done on a John Deere mower, compact tractor, or Gator SUV, but to really understand the feeling, you just have to get in the seat. Learn more at jondere.com/getintheseat or visit a dealer near you. I love learning, and anything that makes learning easier. If you're a parent and your child needs some homework help, then Ixcel is a right for your family. 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Visit ixl.com/moneygirl to get the most effective learning program out there at the best price. Imagine earning a degree that prepares you with real skills for the real world. Capella University's programs teach skills relevant to your career so you can apply what you learn right away. Learn how Capella can make a difference in your life at Capella.edu. You might be wondering what happens if you make contributions to a traditional IRA, but find out later that you don't qualify for a full deduction for those contributions. After all, that's one of the reasons why you might have made traditional IRA contributions to begin with. If you catch this situation before the end of the year, you could withdraw your traditional IRA contributions plus any earnings they made and increase the amount you or your spouse contribute to your employer plan instead. You can withdraw contributions from your IRA tax-free if you do it by the date of your tax return or by your extended due date if you file for an extension. However, the cutoff for making workplace retirement contributions is December 31st, so you'd need to up the ante at work before the calendar flips to a new year. Okay, so let's get back to Bonnie's question. Should she contribute to both a 401k and an IRA or just a 401k? Well, it depends on her tax filing status and income. Let's assume Bonnie is a single woman who makes $40,000. I told you earlier that the threshold for a single taxpayer to get the full IRA deduction is modified adjusted gross income of $56,000 or less. Since she's under that amount, Bonnie can deduct 100% of any amount she chooses to contribute to a traditional IRA, so I'd recommend that she consider it. The major advantage that Bonnie would get for branching out beyond her 401k into an IRA is more flexibility in her investment choices. The typical workplace retirement plan offers a limited menu of funds, so if she's unhappy with her choices at work, an IRA would give her total investment freedom for at least a portion of her retirement money. A disadvantage to using an IRA is that she'd be responsible for making the contributions. It wouldn't happen automatically from a payroll deduction like with her 401k contributions. So if Bonnie isn't disciplined with her investing or doesn't put it on autopilot, she might neglect those IRA contributions. In that case, sticking with the 401k would ensure that the job of investing for retirement gets done. To know if contributing to both a traditional IRA and an employer plan is right for you, first consider whether you make too much money to be eligible for an IRA tax deduction, and then decide whether or not you welcome the idea of having more control over your retirement investing. If you like the tips you get in the MoneyGirl podcast and want to take more control of your money, I think you'll like my book MoneyGirl Smart Moves to Grow Rich. You can even download two free chapters at SmartMovesToGrowRich.com. The book tells you what you need to know about money without bogging you down with what you don't. It's available at your favorite bookstore in print or as an ebook for your Kindle, Nook, iPad, PC, Mac, or smartphone. If you're not already, subscribe to the podcast on iTunes. That's the fastest and most convenient way to get each new show the minute it's released on the web. Several of you have asked about where to find older podcasts that don't show up in the iTunes feed anymore. You'll find them in the MoneyGirl section at quickanddirtytips.com. If you tweet, be sure to follow me. My username on Twitter is Laura Adams with No Spaces. I'm also on Facebook under MoneyGirl. 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