By Liz Pulliam Weston
Times Staff Writer
Individual retirement accounts were made for procrastinators.
Taxpayers can make IRA and Roth IRA contributions as late as the
April tax filing date of the following year. But procrastination
comes at a price.
Money that's not yet invested can't start earning those coveted
tax-deferred returns, and investors who delay can wind up losing
thousands of dollars in foregone profits.
Here's an example, courtesy of financial research firm Ibbotson
Associates.
Say two investors each contribute the maximum $2,000 to their
IRAs starting with the 1994 tax year and continuing until the
1998 tax year. Each invests in low-cost mutual funds that mimic
the Standard & Poor's 500 index.
The early bird makes a contribution as soon after Jan. 1 as
possible, while the procrastinator waits until April of the
following year.
As of Dec. 31, 1999, the early bird would have an IRA worth
$28,927, while the investor who waited would have $6,048 less.
Over time, the gap in wealth would grow. Even if both investors
began making timely contributions in subsequent years, the one
who started early would be ahead by more than $100,000 in 30
years, assuming 10 percent returns.
Of course, the price of waiting is particularly dear when the
stock market booms, as it has in the last decade. But almost any
long-term investment, even in low-risk and low-return vehicles
such as certificates of deposit, can benefit from an early start.
A $2,000 contribution in a CD would earn about $115 at current
interest rates in those crucial 15 months. In future years, that
$115 continues to grow.
Many investors wait because coming up with $2,000 (or $4,000 for
a married couple) can be tough so soon after the holidays. Tax
preparers say some of their clients even fund their IRAs with
that year's tax refunds in a bit of accounting sleight of hand.
The IRS says that's OK, as long as the contribution is made
before the return's due date.
Many people delay until the last minute simply because funding
their retirement may not be at the top of their to-do list.
"I think most people tend to wait until they do their taxes
because that reminds them," said Nancy Langdon Jones, a
financial planner and tax specialist in Upland, Calif. "I
don't think many people say to themselves on Jan. 2, 'I'll rush
right down and fund my IRA.'"
An alternative way to make sure the savings happen would be 12
monthly contributions of $166 (with an $8 addition at the end to
round it up to an even $2,000). Having the contributions
electronically -- and automatically -- transferred from a
checking to a savings or investment account, can make it easier
to save.
Some investors may also be confused about the rules for who can
contribute to an IRA or a Roth IRA.
Anyone with earned income (that's income from wages, salary or
self-employment earnings) can contribute up to $2,000 a year to a
regular IRA. A spouse, working or not, is also allowed to
contribute $2,000. Contributions are allowed even if the investor
has a retirement plan at work -- a source of confusion for some
taxpayers who mistakenly believe that contributions aren't
allowed if they have a pension or 401(k) plan, tax preparers
said.
Having a plan at work affects only whether or not the
contribution is deductible. If the contributor isn't an active
participant in a workplace plan, the contribution is
tax-deductible. (How to know? Look at box 15 of the W-2 form your
employer sends you each year. If the box is checked, you're
considered an active participant.)
Active participants may still deduct an IRA if their income is
below certain limits. Roth IRAs have slightly different rules. If
you can't deduct your traditional IRA, you might as well start a
Roth if you are eligible. Contributions are never tax-deductible
and are not allowed if modified adjusted gross income exceeds
$110,000 for singles and $160,000 for married couples. Like
regular IRAs, Roth IRAs have a phase-out range where partial
contributions are allowed; it begins at $95,000 for singles and
$150,000 for married couples.
Another big difference between regular and Roth IRAs comes when
the money is withdrawn. Withdrawals from regular IRAs in
retirement are subject to income taxes, while withdrawals from
Roth IRAs in retirement are completely tax-free.
One last thing: You are allowed to contribute a maximum of $2,000
to IRA accounts each year. You can't contribute $2,000 to a Roth
IRA and another $2,000 to a traditional IRA; the limit is $2,000
for both.
Copyright © 2001, The Los Angeles Times