By: Lance Teo
An IRA is a retirement investing tool that can be either an "individual retirement account" or
an "individual retirement annuity". There are several types of IRAs: Traditional IRAs, Roth IRAs,
SIMPLE IRAs and SEP IRAs.
Traditional and Roth IRAs are established by individual taxpayers, who are allowed to contribute
100% of compensation (self-employment income for sole proprietors and partners) up to a set maximum
dollar amount. Contributions to the Traditional IRA may be tax-deductible depending on the
taxpayer's income, tax-filing status, and coverage by an employer-sponsored retirement plan. Roth
IRA contributions are not tax-deductible.
SEPs and SIMPLEs are retirement plans established by employers. Individual participant's
contributions are made to SEP IRAs and SIMPLE IRAs.
Investopedia Says... Eventual withdrawal is taxed as income, including the capital gains, but
since your income is likely to be less once you retire, you will be taxed at a lower rate. Combined
with potential tax savings at the time of contribution, IRAs can prove to be very valuable tax
management tools for individuals. Also, depending upon an individual's income, they may be able to
fit themselves into a lower tax bracket with tax-deductible contributions during their working
years while still enjoying a low tax bracket during retirement.
The Pension Protection Act, signed into law on August 17, 2006, is designed to address the
nation-wide problem of under-funded pension plans. The law penalizes noncompliant companies and
encourages employee contributions, but many of the changes directly impact taxpayers of all ages,
regardless of retirement status.
"Taxpayers will benefit from many of the act's provisions, some of which come in the form of tax
breaks, but individuals cannot take full advantage of the tax breaks until the new laws are fully
understood," said Michael Smith, Managing Authorized Taxpayer Representative at tax services firm
FSI Tax Corp.
The following is a rundown of the most important tax code changes and how they will likely
affect taxpayers, as well as retirees.
1. Direct IRA Tax Return Deposits
Taxpayers can now have their tax returns deposited directly into their IRA accounts. The IRS
already offers taxpayers the option to automatically deposit returns into checking and saving
accounts. By adding IRA accounts, legislators hope taxpayers will contribute more funds toward
their retirement accounts.
2. 529 College Savings Plans
Many temporary tax laws enacted by the 2001 tax cuts were made permanent by the Pension
Protection Act. This includes the ability to make withdrawals from 529 college savings plans
without suffering tax penalties.
"Tax-free college savings withdrawals may seem inappropriate in a pension law, but this
provision is welcomed by parents who would otherwise resort to tapping their IRAs to fund their
children's education," said Smith.
3. Saver's Credit
Another 2001 tax break that was set to expire this year is the Saver's Credit, a tax credit
matching up to $2,000 for lower-income workers who put money into their retirement accounts. This
tax break benefits workers who earn less than $25,000 because pre-tax contributions lower the
taxpayer's reportable income and the Saver's Credit provides additional tax relief with its
matching funds.
4. Increased Contribution Levels
In 2001, the IRS temporarily raised employee-sponsored retirement plan contribution levels from
$2,000 to $4,000 this year, $5,000 in 2008 and then adjusted by inflation. The higher limits were
set to expire in 2010, but the act made them a permanent increase.
This change, also intended to encourage increased contribution amounts, applies to 401(k)s,
IRAs, 403(b)s, 457s and catch-up contributions for workers aged 50 and older.
5. Direct Rollovers from a 401(k) to a Roth IRA
Employees who move from one workplace to another were previously permitted to transfer their
401(k)s to traditional IRAs, both of which require taxes to be paid once money is withdrawn. Only
then was the individual allowed to transfer the account into a Roth IRA.
The law now permits former employees to transfer their employer-funded retirement accounts
directly into a Roth IRA, a popular option due to the fact that contributions are made after taxes
are taken from earnings, which means that there are no taxes due upon withdrawing funds.
"The tax code changes enacted by the Pension law benefit taxpayers and steer them toward
contributing to their own retirements," explained Smith. "While companies should be held
accountable for funding employee pensions, each taxpayer should take advantage of changes that make
it easier to ensure a secure retirement."
Tax Deductions for Charitable Giving
Non-pension-related tax code changes include several provisions that significantly increase
charitable giving regulations, some of which are unlikely to please donors.
5. Documenting Items
To discourage taxpayers from inflating the value of non-monetary charitable donations for
inflated tax deductions, the IRS now requires taxpayers to fill out a form detailing the gifts.
Additionally, any significant household item, valued at more than $500, must be appraised before
the taxpayer can take a deduction.
Many charitable organizations, including Goodwill Industries International, say the new
provisions will guard against worthless donations more suitable for the trash bins, but critics
argue that increased regulation will discourage would-be donors and cause a decrease in charitable
giving.
6. Documenting Monetary Gifts
Monetary donations will also require documentation. Regardless of the amount, a taxpayer should
retain proof of any donation. Appropriate documentation can be a bank record, canceled check,
credit card statement or receipt from the charity.
"These records are not required to be included in the tax return but they should be kept on hand
should the IRS request proof," advised Smith.
7. Direct Donations from IRAs for Seniors
Another tax law that many charities support affects only seniors. For the next two years, donors
70 ½ or older will be able to donate to charities directly from their IRAs, an accommodation that
keeps the donated amount tax-free and avoids tax penalties for early withdrawals.
This provision benefits eligible taxpayers who take the standard deduction, which many older
filers do because they receive larger standard deductions. This can also benefit individuals facing
donation limits. Generally, people cannot donate more that 50 percent of their incomes, but the
money does not count as income when it comes directly from the IRA.
Officials at charities such as United Way claim that despite being temporary, this provision
will likely bring in tens of millions of dollars.
Other Pension Provisions
8. Automatic 401(k) Sign Up
Employers are allowed to automatically sign up employees for a 401(k). This change encourages
participation from people who may not otherwise bother to sign up for the plan in the first place,
though they will have the option to opt out.
9. Investment Advice
Because employees often choose safer investments for their 401(k)s, which generally result in
modest returns, the act allows them to receive investment planning advice to encourage riskier
investments with the potential for higher returns. The act also provides protection against
dishonest advisers who steer employees toward decisions that could increase their own profit.
10. Non-Spousal Benefits
Two provisions that expand allowable withdrawals are pleasing gay rights activists. The
non-spousal rollover lets retirement account assets be transferred to a designated beneficiary upon
the retiree's death and the hardship distribution allows retirement account assets be used for a
medical or financial emergency of a beneficiary other than a spouse or a dependent.
The majority of the Pension Protection Act aims to ensure that companies fully fund traditional
pension plans over a seven-year period, starting in 2008. But many provisions promote increased
individual employee participation in retirement planning.
Smith said that while the new law expands allowances and makes it easier for individuals to
increase retirement savings, it may be a step toward employee-funded retirement plans - a move that
has many critics concerned.
Article source: http://www.goarticles.com/cgi-bin/showa.cgi?C=298193
