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Make 2012 Contributions to or Create an IRA Now—Till April 15

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March 2013

It may be March 2013 but it is not too late to make a 2012 contribution to your IRA—Individual Retirement Account. If you don’t have an IRA, you can create one now. To an existing or new IRA you have until April 15, 2013, to make 2012 contributions. An IRA provides individuals a way to save money for retirement and save on income taxes. Having an IRA can be an important retirement savings tool no matter your age or employment status. Why not take a moment to check out these basics?

What is an IRA?

The IRS refers to IRAs as “Individual Retirement Arrangements,” although almost everyone else, including financial institutions, calls them “Individual Retirement Accounts.” An IRA is a personal tax-advantaged savings vehicle in which you hold a portfolio of different investment instruments.

Different financial institutions such as credit unions, banks, insurance companies and brokerages may offer IRAs. The investment options for your selection within an IRA typically vary from provider to provider. However, all will offer a variety of investment instruments, such as CDs, money market funds, and mutual funds (including stock or bond funds), to enable you to diversify your investments.

The two most common forms of IRAs are “traditional” and “Roth” IRAs. They differ primarily in how the tax advantages work. The maximum annual contribution in 2012 for either IRA is $5000 or your total taxable compensation, whichever is smaller. Individuals age 50 and over may contribute up to $6000. In 2013 these maximums increase to $5500 and $6500. If you (or your spouse) also have a retirement plan through your employer, such as a 401k, your allowable contribution may be decreased or phased out depending on whether you meet certain income criteria.

Individual Retirement Accounts

Traditional

  • Contributions are tax deductible in the year of contribution.
  • Earnings grow tax free.
  • Pay tax at the time of withdrawal.
  • Withdrawals can begin at age 59½ but must begin by age 70½.
  • Withdrawals made before age 59½ incur a 10% penalty.

Roth

  • Contributions are not tax deductible.
  • Earnings grow tax free.
  • Withdrawals are not taxed.
  • Withdrawals can begin at age 59½ but you do not have to start by a particular age.
  • Withdrawals before age 59½ from the amount contributed are penalty free but withdrawals from earnings before age 59½ incur a 10% penalty.

Traditional IRA. In a traditional IRA you are able to deduct all or the allowable portion of your contribution from your taxable income in the year of the contribution. The money you put in the IRA and its earnings then grow tax-free until you begin to take distributions from the IRA, usually in retirement. Income tax is then due on those distributions.

You may begin to take distributions without penalty at age 59½ and must do so by age 70½. If you withdraw money earlier, you will pay a 10% penalty plus the income tax due on it unless the money is for one of several limited uses such as paying for college, buying a first home, or extreme medical expenses.

Roth IRA. In a Roth IRA, you make contributions from money on which you have paid income tax. That means you don’t deduct the amount of these contributions from your taxable income. Instead, the money earned in a Roth IRA grows tax-free and distributions from earnings are tax-free when you begin to take distributions at age 59½. Unlike a traditional IRA, you can continue to make contributions to a Roth IRA after you reach age 70½ and do not have to start taking distributions at this age.

Another difference of the Roth IRA from the traditional IRA is that you may take penalty-free withdrawals from the amount of contributions to the IRA at any time and for any reason. If you withdraw any of the earnings before you reach age 59½, however, you will pay a 10% penalty.

Who Needs an IRA?

Financial and retirement planners note that having an appropriate IRA makes sense for most individuals because IRAs offer a way to enjoy income tax-advantaged earnings as you save for retirement or other allowed purposes. But having an IRA is even more important in certain circumstances:

  • Your employer offers no retirement savings plan. This situation may apply particularly to young adults or students who are just getting started on their careers or work a variety of jobs.
  • You are a young adult just beginning your career. Even if your employer offers a retirement savings plan, starting a Roth IRA when your income tax bracket is typically lower may be an excellent way to build additional savings tax-free.
  • You are self-employed. One basic retirement savings option for a self-employed individual or small business is a SEP-IRA. Read more about it in IRS Publication 560.
  • Your work-related retirement plan is inadequate. If projected income from your work-related retirement savings plan plus Social Security may not meet your projected income needs for retirement, it may make sense to have a personal IRA in addition, if you qualify.

Where Can You Set Up an IRA?

Many financial institutions, including credit unions, banks, insurance companies and brokerages, offer IRAs. I recommend looking first at your credit union. One advantage is that basic IRAs at many credit unions are NCUA-insured up to $250,000 (traditional and Roth IRAs combined). The IRA accounts are insured separately from other accounts you may hold at a credit union. IRAs established at a bank may also be federally insured. IRAs at institutions such as insurance companies and brokerages are not federally insured. A special note: Some credit unions may also offer IRAs through a related CUSO that may offer the services of an investment company or investment advisors. While such IRAs are not usually insured, they may offer wider investment options, and credit unions typically create investment CUSOs with care to place member interests first. UFCU offers this option through CUSO Financial Services L.P.

For all IRA options, you will want to compare not only the investment options offered within each IRA possibility but also the fee structures of the IRAs. How easy is it to manage your account? Can you do it online? Are the individuals and materials (online and/or printed) clear and helpful? Does the firm keep a beneficiary form on file and can you obtain a copy for your records? Satisfactory answers to these questions can help you choose the option most appropriate for you.

“A Penny Saved is a Penny Earned”

Founding Father Benjamin Franklin is credited with this famous saying. It is certainly true when it comes to Individual Retirement Accounts. Saving in an IRA offers a way to grow your money in a tax-favored plan that can help your “pennies” multiply a little quicker because taxes are typically reduced in the long-term.

For More Information

UFCU IRAs

IRS Publication 590: Individual Retirement Arrangements (IRAs)

getREAL Retirement Planning Guide

CNNMoney’s Ultimate Guide to Retirement: IRAs

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