Traditional IRA changes

Traditional IRA changes

Host : Wow. I can see the new law may have benefits, but it certainly doesn't promote simplicity.

We've talked about education IRAs, but what about good old fashioned IRAs. Weren't there changes here as well?

David : Yes. The new law improves on the traditional IRA, and it adds a new type of IRA called the Roth IRA which, unlike the education IRA, really is meant for retirement.

But before we talk about the Roth IRA, let's discuss the traditional IRA.

The traditional IRA has two great features. The first is immediate deductibility of your contribution. So if you contribute $2,000 to an IRA, you might reduce this year's tax liability by $600.

The second great feature is tax-deferred earnings. You don't have to pay income taxes until you withdraw money from the IRA.

However, in the mid-1980s Congress reduced the first benefit. They felt too many people were reducing their taxes too much by making deductible contributions, so they reduced your ability to deduct your IRA contribution.

Specifically, if you were covered by a retirement plan at work, Congress phased out your up-front tax benefit of an IRA. They said that if you're single and your income was above $25,000, or married with a $40,000 income, your ability to deduct the contribution would be phased-out.

Host : So does the new law change this?

David : Yes. The income phase-outs I just mentioned eventually will double for singles and joint filers. However, this doubling occurs gradually over the next eight years or so. So if you're middle class and are covered by a retirement plan at work, you're ability to deduct an IRA contribution increases, but it comes in dribs and drabs over the next decade.

Host : Doesn't the retirement plan of your spouse also affect this?

David : Right, and this is another positive change. Previously, if your spouse was covered by a corporate retirement plan like a pension or 401(k), you had trouble deducting your IRA contribution. Now your ability to deduct your IRA contribution is effectively decoupled from your spouse's retirement plan status.

Host : And what about the $2,000 maximum contribution. Has that changed?

David : Not yet, but it now will change in the future with inflation in $50 increments. Contributions have been stuck at $2,000 of earned income ever since IRAs were introduced in the early 1980s. Inflation, however, has eroded the value of this contribution, so the new inflation indexing is a welcome change.

There are other relaxations as well. You now can make penalty-free withdrawals from your IRA to pay for college or to make up to $10,000 worth of payments on a first home.

But remember if you're withdrawing any money from a traditional IRA, you'll have to pay ordinary income taxes on the withdrawals. It's just in these cases you won't have to pay the additional 10 percent penalty tax.

Another relaxation is the elimination of the so-called success tax. This tax meant that if you died with too much money in your IRA, the government claimed about 70 percent of your money. With the elimination of the success tax, it now only claims about 40 percent of it.

Host : David, I'd like to continue talking about IRA changes, but we've come to the end of the first half of our program. If you're listening to this program via audio tape, please fast forward the tape and turn the cassette over.