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Deciding on an IRA

There have been significant changes made in the way Americans save for retirement since the enactment of the Tax Reform Act of 1986. The rules for Individual Retirement Accounts (IRAs) now effectively exclude many individuals who have higher incomes and are covered by retirement plans provided by their employers.

There are several things you need to know to determine whether you qualify for an IRA deduction and, if you do, whether the actual deduction will be as beneficial as some other alternatives.

If you and your spouse are covered by a retirement plan at work, your income determines whether your IRA contribution will be fully deductible, partially deductible, or not deductible at all. In 2015, if you are married, filing a joint return, and your adjusted gross income (AGI) is $98,000 or less, you are entitled to a full deduction of $5,500. If your joint income is between $98,001 and $118,000, you are entitled to a partial deduction. If you have an income—combined or otherwise—of over $118,000, you are ineligible for a tax deduction on your IRA contributions. If you don’t have a workplace retirement plan but are married to someone who does, the tax deduction for an IRA contribution is phased out if your combined income is between $183,000 and $193,000 in 2015.

Single individuals earning $61,000 or less are entitled to a full deduction of $5,500. On incomes between $61,001 and $71,000, individuals are allowed a partial deduction. Single individuals with incomes over $71,000 are not allowed an IRA deduction.

Of course, even though deductions at specific income levels are either reduced or eliminated, contributions to IRAs are still allowable on a nondeductible basis. One major advantage of this is tax-deferred accumulation. The Internal Revenue Service (IRS) has indicated that it is the individual’s responsibility to maintain accurate records as to which contributions, if any, are deductible.

If your primary objective, in addition to retirement savings, is to defer taxes on the interest you earn, you may wish to consider an IRA. In addition, you may want to supplement IRA retirement savings by contributing to alternative investments, which also grow tax-deferred without many of the penalties and restrictions of an IRA. Other tax-deferred investments that provide flexible benefits include annuities and life insurance.

Withdrawing money prior to age 59½ imposes a 10% penalty, in addition to the income tax on the amount withdrawn from the IRA. In addition, you must begin withdrawing money from an IRA by age 70 ½. If you do not withdraw adequate funds by that time, you will be subject to a 50% penalty on the amount not distributed.

If you are like some individuals, you may wonder if you should terminate an existing IRA or cancel plans to start one. The answer depends on your needs and goals. IRAs still represent an attractive investment choice for helping provide long-term savings; but you may require more. For example, the most you can set aside each year in an IRA is $5,500 ($6,500 if you are age 50 or older). That amount may be insufficient to meet your retirement needs. Therefore, it may be beneficial to consider other options in combination with an IRA. You could retain your yearly IRA and begin to put additional contributions into an alternative investment.

For example, life insurance performs two tasks. First, it provides protection and, second, it provides tax-deferred savings on each premium payment. In addition, the policyholder has access to the money. At retirement time, cash value life insurance can be converted to an annuity that will provide a lifetime income.

Most life insurance plans can be set up to guarantee that if a serious illness or accident keeps you out of work, your premium payments will be made for you until you resume work. The IRS does not consider these payments taxable income.

Lastly, all cash value policies provide your dependents and beneficiaries with death benefits that are tax-free income. Life insurance can provide retirement income that will be excluded by the government when taxing your Social Security retirement benefits.

You will need to perform an initial analysis to determine whether any of the alternatives listed above—in combination with an IRA—would be appropriate for you.

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