As with most retirement plans the contributions are tax deductible, tax deferred and require minimum distributions at a certain point in the individual’s retirement. This article explains these basic rules. 

It is important for the reader to understand that the primary benefit associated with any retirement plan is time value of money. By utilizing time and the compounding of earnings, retirement plans can generate significant financial resources upon retirement. The earlier you begin to save, the greater the value time will yield. Deciding to save after age 50 creates concern for inadequate funds upon retirement. Start early and consistently save every year. 

The Internal Revenue Service under Code Section 408 allows three types of IRA accounts. The first and very common with small business is the Simplified Employee Pension (SEP) under Code Section 408(k). With this type of plan, the employee deposits earnings into a traditional IRA account via a payroll deduction. A second type of small business IRA based plan is the Savings  Incentive Match Plan for Employees or SIMPLE under Code Section 408(p). Finally the most commonly known form is the traditional IRA under Code Section 219. This traditional form is handled and managed by the taxpayer directly and does not involve the employer. 

Primary Benefit of an IRA 

The primary benefit of an IRA is the tax deductible status of the contributions made by the taxpayer against the total gross income earned during the tax year. There is a caveat here; if the taxpayer or the taxpayer’s spouse has access to a retirement plan via their employer, the contributions are limited or completely eliminated based on the circumstances. 

In general the taxpayer may deduct up to $5,500 for the tax year 2015. However, if the taxpayer is age 50 or older, there is an additional deductible allowance of $1,000 thus the absolute maximum is $6,500. This is referred to as the Catch-Up rule.  

The best part is that the taxpayer has until the tax form due date to make the contribution. For the tax year 2015, the taxpayer has until April 15^th, 2016 to make their contribution to a traditional IRA account and take the deduction on their 2015 Form 1040. 

For the purposes of the gross income deduction, only earned income and alimony is used to determine the compensation limit. The taxpayer is limited in their deduction of the lesser of their compensation or the allowed deduction ($5,500 for those less than 50, $6,500 for those 50 or older). If your earned income on your W-2 is only $4,950; then you are limited to $4,950 as your contribution. 

The benefit derived is naturally the savings associated with reducing your income tax.  So if you are in the 15% bracket and you contribute $5,000 then your tax savings would equal $750. This is much more beneficial to those living in states that also tax your income as income taxing states also recognize this deduction in determining their tax.  

This appears to be a wonderful benefit; however there are limits and the basic limit is your adjusted gross income. In general the adjusted gross income is the total amount you record as income on your tax return. You may exclude any social security income. However, you must add back any passive activity losses. In tax lingo, this is referred to as Modified Adjusted Gross Income. 

For the reader, the primary limiting question is access to a retirement plan at work for either you or your spouse. If you have no available plan via your respective employers, then your gross income limit is nonexistent; in effect you are free to make the maximum contribution to an IRA. However, if you do have access to a plan at work or your spouse has one, the following are the modified adjusted gross income limits: 

• Single – $61,000 with a phase-out of the tax deductible amount between $61,000 and $71,000
• Married Filing Jointly – $98,0000 with a phase-out of the tax deductible amount between $98,000 and $118,000
• Married Filing Separately – phase out up to $10,000; no deduction after $10,000 

I realize that this appears confusing. But basically the government is allowing those without access to a retirement plan the ability to contribute to an IRA. For those that have access, the government is limiting your access because they want you to participate in your employer’s plan. For most of my readers, you own your business or you are involved in a small business operation and the above may seem overwhelming. Suffice it to say that you may contribute to an IRA if you do not have a plan set up in your company. If you have a company plan, then basically you must use that plan to save for retirement and you should use that plan. After all you went through the trouble to establish the company plan so participate in that plan. 

For those of you that are self-employed, set up an IRA through a broker or online account and make contributions. My final example relates to a very common group of married couples whereby only one spouse earns money and there is no access to a company retirement plan. 

Joe and Patty own a small retail store.  Both work the store and the store nets them $110,000 per year. The store is legally owned by Patty and therefore the income is recorded on the combined return via Schedule C.  How much can they contribute to their IRA’s? 

Answer:  Congress did not want to penalize the spouse, in this case Joe, so the rules allow both Patty and Joe to contribute up to their allowed amount based on age ($5,500 or $6,500) to their respective IRA accounts. The rules allow the one spouse that has no legal income the right to ‘Borrow’ the income from the earning spouse and use this amount as his compensation. If both are under age 50, then each may contribute up to $5,500 into their respective IRA’s for combined total of $11,000.

Once the contribution is made into the account, the second benefit for the taxpayer begins. 

Tax Deferral on Income Earned in an IRA 

The best part of saving money is taking advantage of compound growth. Basically compound growth is earning a return on your earnings throughout the life of the investment. The following chart illustrates this well. An initial investment in your IRA at age 24 and allowing it to grow to age 65 at 4.8% per year with an initial investment of $5,500 means that the account balance will equal $37,599 at the terminal end. 

Since IRA’s are tax deferred, this means none of the earnings from year to year are taxed. If the earnings were taxed and for this illustration I’ll assume 15%, what would be the terminal value? Answer: $28,341.

This is a whopping $9,258 difference between a true tax deferred investment and a taxed investment. Basically the taxpayer is earning money on the tax that otherwise would have to be paid. To gain the maximum benefit for an IRA the taxpayer should begin early in life depositing money into their Individual Retirement Account.

Once you get to retirement age, it is time to withdraw the money. Well, there are rules regarding distributions. 

Distribution Rules for IRA’s 

Your traditional IRA’s are subject to the same rules used with employer provided retirement plans. To begin, the most important rule is that you MUST begin to take distributions from your IRA no later than April 1 following the calendar year you turn 70 and ½ years old. As an example: if your birthday falls in November, you will turn 70 and ½ in May of the following year. This means that you must begin to take distributions by April of the next year. Basically, if your birthday is in November you can wait until you are 71 years and 4 months old to begin taking distributions. 

The required minimum distribution is a formula based on the UNIFORM LIFETIME TABLE. This table basically determines the expected remaining life for the taxpayer based on their age once they hit age 70. In effect, the minimum distribution is lower at age 70 than at age 80. Essentially the table forces the taxpayer to continuously increase their minimum percentage as they age in order to deplete the IRA balances and pay the associated income taxes. There is no minimum requirement prior to age 70.  

In layman’s terms, at age 70 you will need to take at least 3.65% of your total IRA account balance as a distribution to stay in compliance. At age 80, you are required to take at least 5.35% of your total account balance. If you should live to age 115, you are required to take 52.7% of your remaining IRA balance. If you live to age 116, you can do whatever you want because it will take the IRS several years to figure it out and you’ll be dead anyway! 

Most retirees defer taking distributions from their IRA’s until the required deadline and use other resources in the interim during the retirement years.  

Summary – Individual Retirement Accounts

These are the most basic rules related to IRA’s. There are a bunch more rules but they involve early withdrawals which generally have abusive tax penalties. Other issues relate to death or early retirement. I have another article that gets into the nuances of these particulars. Since they are rather detailed and not really applicable for an introduction article, I did not discuss them here. 

The main point of this article is that IRA’s act as a filler plan for many Americans that do not have access to an employer provided retirement plan. In addition, it augments existing employer plans especially those that provide only minimum contributions on behalf of the employee. Contributions are tax deductible and tax deferred while those funds reside in the IRA account. The tax deferral benefit allows the account balance to grow at a much faster rate than the traditional taxed forms of savings. 

The final basic rule requires owners of IRA accounts to take minimum distributions once they reach age 70 and ½. The required minimum distribution increases as the retiree ages. 

As a taxpayer and for your personal financial health you should take advantage of the IRA and begin to save money now. Act on Knowledge.

Value Investing

Do you want to learn how to get returns like this?

Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.

There are four key principles used with value investing. Each is required. They are:

1. Risk Reduction – Buy only high quality stocks;
2. Intrinsic Value – The underlying assets and operations are of good quality and performance;
3. Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
4. Patience – Allow time to work for the investor.

If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above. 

Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:

1. Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
2. Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
3. Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.

Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:

• Lessons about value investing and the principles involved;
• Free webinars from the author following up the lessons;
• Charts, graphs, tutorials, templates and resources to use when you create your own pool;
• Access to existing pools and their respective data models along with buy/sell triggers;
• Follow along with the investment fund and its weekly updates;
• White papers addressing financial principles and proper interpretation methods; AND
• Some simple good advice.

Value Investment Club

• Value Investment Club Annual Membership
  $99.99
  Value investing utilizes a buy low, sell high tenet of systematic processing. Along with patience, value investors reap substantially greater returns than most of the market measurment indices (DOW, Russell 200, S&P, etc.). During the first year, this investment fund earned a 23.52% return while the DOW generated a 6.5% return. When you subscribe, you receive access to all existing articles, books, lessons, webinars and reports explaining how value investing works. In addition, each week, the subscriber receives additional articles, reports and buy/sell points for high quality stock purchases. Follow along as the fund updates regularly and discover how to invest like a pro and earn excellent returns on your investment. Subscription is for one year of access to the value investing pool of information and formulas.

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