Traditional IRA
Anyone under the age of 70½ with earned income is eligible to make contributions to a Traditional IRA. A primary incentive for opening an IRA is to reap the tax benefits it offers. IRAs are especially useful because pension benefits have been declining in recent years; many employers are cutting back on the benefits offered, and because workers are changing jobs more often, they accrue fewer pension benefits in general.
Tax Incentives
A Traditional IRA offers two distinct tax advantages:
- Part or all of your annual IRA contribution may be tax deductible on a federal level. In general, how much you can deduct is determined by your income and whether you participate in an employer-sponsored retirement plan (such as a 401(k) account).Your personal tax adviser can better explain how the Traditional IRA's tax-deductibility rules affect you.
- All gains from your IRA, such as capital gains, dividends, or interest, are tax deferred until you make withdrawals. This means more money will be available to generate growth.
This chart below compares a deductible Traditional IRA investment of $3,000 made at the beginning of each year with an annual non-deductible investment of $3,000 made into a taxable investment account at the beginning of each year. For both accounts, assume a hypothetical growth rate of 8 percent and a 28 percent federal tax rate.
More about the assumptions:
- Your actual tax rate on the withdrawal of gains from a tax-deferred account could be more or less than 28%, depending upon the applicable tax rates that are then in effect, and whether you make your withdrawal in a lump sum or over time. Your effective tax rate on gains from a taxable account could also be more or less than 28%, depending upon you adjusted gross income and the nature of the gains. Currently, qualifying dividend income and long-term gains form a taxable account are taxed at an individual's capital gains rate, which is 15% or lower. Capital gains taxation is not available for gains taken from a tax-deferred account. The differences between the tax-deferred and taxable returns shown in the example would therefore be smaller if (a) your effective federal tax rate on the gains from a taxable account were lower than 28% or (b) your federal tax rate on a withdrawal from a tax-deferred account were greater than 28%.
- The hypothetical 8% investment return is compounded annually and assumes reinvestment of dividends and capital gains
- The value of the Traditional IRA after a lump sum withdrawal taxed at 28% is $33,794 if taken after 10 years, $106,753 if taken after 20 years, and $264,267 if taken after 30 years.
Hypothetical results are for illustrative purposes only and are not intended to represent the past or future performance of any specific securities. Investment return and principal will fluctuate so that shares, when redeemed, may be worth more or less than their original value. Withdrawals prior to age 59½ may be subject to ordinary income tax and a 10% penalty.
Limits
In 2008, single working Americans can contribute up to $5,000 into IRAs (or the sum of their earned income, whichever is less.) A married taxpayer in a single-income household can contribute up to $10,000 ($5,000 in each spouse's individual IRAs). There is an additional “catch-up” provision for those over age 50 which would allow individuals to contribute an additional $1,000. It is important to note that contributions made into a Traditional IRA will reduce the contribution limit in a Roth IRA account.
The most important thing to remember about your IRA is that it was intended to be a retirement planning vehicle. Taking money out of your account before you reach the age of 59½ will generally result in a 10% penalty, in addition to taxes. There are exceptions to this rule, and your registered representative can explain them to you. Also, traditional IRA distributions must begin by the time you are 70½.
For more information about First Investors funds when planning your Traditional IRA, you may obtain a free prospectus and shareholder manual by contacting your registered representative, writing to the address below, or calling (800) 423-4026. You should consider the investment objectives, risks, charges and expenses of the funds carefully before investing. The prospectus contains this and other information about the funds, and should be read carefully before you invest or send money. An investment in these funds is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency.
