Here’s a question about Social Security that I came across not too long ago:

I’m in my 60′s and am receiving Social Security every month.  How much, if any, can I still contribute to my Roth IRA?

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In other words, the question is  – Is Social Security income?  Or more specifically, is it earned income.  So here’s the answer:

Social Security Does Count as Income

Yes, Social Security is definitely income received.  However, it doesn’t mean it’s fully taxable.  To the extent that the IRS looks at your Social Security as income that must be included for tax purposes depends upon how much income you earn from other sources and your marital status.

In 2010, the IRS has base amounts of:

• $32,000 for married couples filing jointly
• $25,000 for single, head of household, qualifying widow/widower with a dependent child, or married individuals filing separately who did not live with their spouses at any time during the year
• $0 for married persons filing separately who lived together during the year

In other words, if you make more than the base amounts you must include Social Security as income for tax purposes.  To learn more check out Publication 915 from the IRS.

Social Security Does Not Count as Earned Income

Is Social Security income?  Not in the sense of earned income. Social Security income is not earned. In order to contribute to a Roth IRA (as the question asks) or a Traditional IRA, you must have earned income equal to the amount of your contribution.

Earned income includes:

• wages
• salaries
• commissions
• professional fees
• bonuses
• self-employment income, etc.

You could have income from any of these sources and contribute that earned income to a Roth IRA or Traditional IRA.

The max contributions for 2011 are $5,000 per individual under age 50 and $6,000 per individual if over age 50.

The Answer to the Question

The answer to this question is, “It depends.”  It really depends if this individual is receiving any type of earned income.  If so, then they can contribute any amount of that earned income up to $6,000.

If Social Security is their only source of income, then the answer is no, they cannot contribute to a Roth IRA.

Have a Question?

Contact me with your questions. Yours could be included in the next blog post!

Need cash?  Thinking about taking an IRA withdrawal?

Think long and hard because you may have to pay  a nice little 10% penalty for early IRA withdrawals!

IRA penalty – Oh yeah, Uncle Sam will love you!

If you are age 59 1/2 or older, you can take an IRA withdrawal without any penalties at all.

If you’re younger than age 59 1/2 you’ll have to pony up for an IRA penalty – unless of course you meet one of the exceptions below.

IRS publication 590 lists these exceptions to the 10% penalty for an early IRA withdrawal:

1. You take an early IRA withdrawal and you have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.

If you have a lot of medical debt, you may be able to take out IRA money without that 10% penalty.  Remember, medical expenses must be higher than 7.5% of your adjusted gross income.

2. You can take an early IRA withdrawal for medical insurance

As long as your IRA distribution is not more than you paid for medical insurance you will not have to pay a 10% penalty if the following applies:

• You lost your job
• You received unemployment for 12 consecutive weeks because you lost your job
• You receive the IRA distributions during the year you received unemployment or the following year
• You receive distributions no later than 60 days after you’ve been re-employed

3. You can take an early IRA withdrawal if you are disabled.

Bad news – you’re disabled.  Good news – no penalty.  Not sure I’d really want to qualify for this one, but it is there.  Be sure to file a special tax form with your 1040 that lets the IRS know that you are disabled!

By the way – it’s a good idea to check out disability insurance before you become disabled too!

4. If you are the beneficiary of a deceased IRA owner, you can take an IRA withdrawal.

Ok, so Uncle Ritchie leaves you his IRA and you’d like to go buy a new 5 Series – no penalty!

5. Your IRA withdrawal consists of receiving distributions in the form of an annuity.

Basically what the IRS means here is that you must take “substantially equal period payments”  – in other words a set amount per year for either a) five years or b) til 59 1/2, whichever is longer.

6. Your IRA withdrawal is not more than your qualified higher education expenses.

Alright, so you’d like to use your IRA money for college savings!  Great news – your IRA withdrawal (as long as it is not more than your tuition) can be taken penalty free!!

7. Your IRA withdrawal is used to buy, build, or rebuild a first home.

First home.  That’s the key here.  Not your second, third or fourth – it’s your first home and you are buying, building or rebuilding – then you can take an IRA withdrawal penalty free.

Guess what though – a first-time homebuyer is actually defined as a homebuyer who has not lived in a main “purchased” home for the preceding two years.

So, if you owned a home, sold it and rented for over 2 years and then decided to buy again – you’d qualify!!

8. Your IRA withdrawal is a qualified reservist distribution

A qualified reservist distribution is met if:

• You were ordered or called to active duty after September 11, 2001
• You were ordered or called to active duty for a period of more than 179 days or for an indefinite period because you are a member of a  reserve component
• The distribution is from an IRA, 401k or 403b plan
• The IRA withdrawal is made no earlier than the date of the order or call to active duty and no later than the close of the active duty period

These exceptions have some qualifiers on them so it’s important to look at the IRS publication to make sure you fit into one of these categories before you take the money out.

Also, don’t fall into the trap thinking that these exceptions are for taxes!  You still have to pay taxes on any withdrawal you take out.  The exception is for the penalty only!

So there you have it, 8 ways to avoid the penalty for your IRA withdrawal!

This post was included in the Tax Carnival #75!

For some reason I get this question a lot, so I thought I’d provide a little clarification on IRA withdrawal rules.

Individual Retirement Arrangements or IRAs were designed to provide an opportunity for folks to save for retirement on a pre-tax, tax-deferred basis.  In other words, the money grows without having to pay any taxes on the gains.

Of course, with an IRA you have to pay the Piper at some point in time.  That means when you get into retirement and start your IRA withdrawals, you’ll have to pay taxes.  This can create a “tax-time bomb” in retirement, but I won’t get into that here.

The short answer to when you can take your IRA withdrawals is – any time! 

People are often shocked by that answer, but it’s true. 

You can access your money through an IRA withdrawal any time you’d like, but you just better be aware of the tax and penalty ramifications.

If you take your IRA withdrawal after age 59 1/2 you won’t have to worry about any penalties, just the taxes. 

There are some exceptions to taking money out before age 59 1/2, so let’s take a look at an early IRA withdrawal:

Your IRA Withdrawal Prior to Age 59 1/2

The general rule is that if you take an IRA withdrawal before 59 1/2 the IRS whacks you with a 10% penalty.  So, ideally you need to wait on your IRA withdrawal until you reach that age.

As with most IRS rules, there are some exceptions:

IRS publication 590 lists these exceptions to the 10% penalty for early IRA withdrawals:

• You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
• The distributions are not more than the cost of your medical insurance
• You are disabled.
• You are the beneficiary of a deceased IRA owner.
• You are receiving distributions in the form of an annuity.
• The distributions are not more than your qualified higher education expenses.
• You use the distributions to buy, build, or rebuild a frist home.
• The distribution is due to an IRS levy of the qualified plan.
• The distribution is a qualified reservist distribution

These exceptions to the early IRA withdrawal rules have some qualifiers on them so it’s important to look at the IRS publication to make sure you fit into one of these categories before you take the money out.

For example, the exception that says you can take the money in the form of annuity – basically what the IRS means here is that you must take “substantially equal period payments”  – in other words a set amount per year for either a) five years or b) til 59 1/2, whichever is longer.

Also, be aware that these exceptions are for the 10% premature distribution penalty NOT taxes!  You still have to pay taxes on any IRA withdrawal.

Your IRA Withdrawal After Age 59 1/2

Reaching the magic age of 59 1/2 is one retirement milestone you should look forward to.

Once you reach this age, you can begin to take your IRA withdrawal penalty free!  At this point you can take out as much as you want, whenever you want.

Again, there is no escaping the taxes (unless of course you open a Roth IRA) so just be aware that every dollar you pull out will be as if you earned that money for the year – it counts as ordinary income.

By the way, you literally must reach age 59 1/2 – not 59, 5 months and 15 days. You can take the money any time on the day you turn 59 1/2 or after.

Just because you turned 59 1/2 doesn’t mean you have to take the money out though.  You may not want to.  If you’ve done a good job establishing other sources of income, you may decide to wait.

Your IRA Withdrawal at Age 70 1/2

If you do decide to wait however, you won’t be able to leave that money in your IRA forever.

At age 70 1/2 you will be required to take a minimum distribution ( also known as RMD, which uses a formula set up by the IRS to determine the amount) and pay taxes on those withdrawals.

But, what if you don’t need the money and you’d rather wait?  That’s fine, but just know that good ol’ Uncle Sam will uppercut you with a 50% penalty on the amount that should’ve been distributed along with the normal taxes due.

They want to make sure they get their tax revenue some how. So be aware that sooner or later you HAVE to take money out of your IRA.

So remember, you can always take an IRA withdrawal, but you need to know the right rules and regulations to determine when a distribution will be right for you.

This was a post I originally did for ChristianPF.com and thought I’d share it here as well.

Who doesn’t want a little extra cash for retirement?  Of course, we all do.  But since money doesn’t grow on trees we have to find a few ways to create our own money tree.

Let’s take a simple look at how easy it could be to grab some extra cash for retirement, but first let’s start with the basics.

401k Contribution Rules

We need to rview the 401k contribution rules so we’re all on the same page.  In 2010, the contribution limit to a 401k is $16,500 if you are under the age of 50.

If you are over the age of 50 you get the opportunity for a $5,500 catch-up contribution so the total you can throw in your 401k is $22,000!

That is a HUGE opportunity for some additional retirement savings!

Extra Money for Retirement Savings

Let’s assume you are age 50 and you want to retire at age 65, so you’ve got 15 years until that magical age of retirement. 

Let’s also assume that you are currently contributing the max to your 401k or $16,500.  You now have an opportunity to throw in an extra $5,500 to your 401k, but you’re just not sure you want to.

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Do the Math!

Let’s just do a simple Time Value of Money (TVM) calculation to give you sense of what the catch-up contribution could net you when it’s all said and done.

Let’s say you’re contributing $16,500 to your 401k – here’s what an extra $5,500 will do

• PMT (payment or contribution) = $5,500
• PV (present value) = $0 – we’ll assume zero for the sake of argument
• Rate (interest rate earned) = 8% – this is fairly moderate – not too aggressive, not too conservative
• N (number of periods) = 15 years – we’ll compound annually
• Solve For FV (future value) = The answer we come up with is $149,336.63!

You are essentially grabbing an extra $150,000 just by doing the catch-up! 

What If I’m Not Age 50?

Okay, for you younger folks who aren’t able to do the “catch-up”, let’s take a look at what a maxed out IRA will look like if you start now!

The IRA contribution limits are currently $5,000 annually for those under the age of 50.  Let’s do some simple math again:

• PMT (payment or contribution) = $5,000
• PV (present value) = $0 – again, we’ll assume zero for the sake of argument
• Rate (interest rate earned) = 8% – this is fairly moderate – not too aggressive, not too conservative
• N (number of periods) = 30 years – we’ll assume your 30 years old and want to retire at age 60!
• Solve For FV (future value) = The answer we come up with is $566,416.06

Not too shabby – more than a half mildo just by maxing out your IRA! 

It’s Not That Simple

Okay, okay, I know that no one earns 8% every single year for 30 years. The problem with these types of calculations is that they are totally unrealistic!  But here’s the point – don’t hesitate to start saving for retirement or any other goal you have.

It Really Is That Simple

Huh?  Yes, it is simple – because the bottom line is that the sooner you get started and the more you can put away – the greater the impact compound interest will have on your portfolio! 

Maybe it won’t be $500,000 or even $150,000 additional savings – but anything is better than nothing!

So, what are you waiting for!? 

Let me know your thoughts

1. Are you maxing out your 401k or IRA?
2. Do you plan on saving additional money this year for your retirement goal?

No doubt most people have heard of a Roth IRA, after all, they’ve been around since 1998.  Although they’ve been available for over 11 years, I’m constantly amazed by how many people are just simply unsure of exactly what they are or what they do. 

The Basics: What is an IRA?

An IRA is simply an Individual Retirement Account (IRA) that provides investors an opportunity to save for retirement in a tax-advantaged way.  Generally, you must wait until 59 1/2 to withdraw the money without IRS penalty. 

A Roth IRA is an Individual Retirement Account named after its legislative sponsor, late senator Bill Roth, that was established in 1998 to provide an alternative method of saving for retirement that offers different tax advantages than the Traditional IRA. 

Features

The main difference between the Traditional and the Roth IRA is how it is taxed.  With a Traditional  IRA, you typically contribute before-tax (with some exceptions) money to the account.  Depending on your eligibility, you can deduct your contributions from your income on your current year taxes.  You receive the tax break now.  The money grows tax-deferred so when you pull your savings out in retirement you have to pay taxes on every single dollar you withdraw at whatever your current tax rate is at the time.

The Roth IRA is just the opposite.  You contribute after-tax dollars to the account and the money still grows tax-deferred.  You cannot deduct your contributions; however, in retirement you can withdraw your money (provided you meet certain qualifications) completely tax free. Not only that, but as long as your Roth IRA has been in existence for five years, your beneficiaries on the account can pull out money income-tax free, so the Roth IRA becomes a nifty estate planning tool as well.

Advantages

1. Obviously the biggest advantage to the Roth IRA is the tax-free withdrawals in retirement.  This can be a huge potential tax savings for you especially if you think tax rates will be going up.

2. The Roth offers more flexibility on withdrawals prior to retirement.  You can withdraw your principal (your contributions)  tax and penalty free at any time during the life of the Roth IRA.  To an undisciplined person might have trouble with this, but someone who runs into a bind an is cash strapped can have a little comfort knowing they have some additional money available.  This is a huge plus compared to the Traditional IRA, where you would pay a 10% penalty on any pre-59 1/2 withdrawals as well as taxes.  

3. Another advantage is that you can contribute to the Roth even if you are covered by an employer-sponsored retirement plan (401k etc).  With the Traditional IRA you are subject to income testing to determine if you could contribute when covered already by a plan  at work. Even if you could contribute, you don’t get to take advantage of the deduction on your taxes.  So the Roth becomes the perfect additional savings plan when you already have a 401k or other employer plan.

 4. For older folks, the fact that you do not have to take withdrawals is a major advantage as well.  With a Traditional IRA, the government forces you to take money out at age 70 1/2 or face a 50% penalty for not withdrawing your savings.  The main reason is of course to generate tax revenue.  Since Roth IRA distributions are tax free, you don’t have to worry about this rule. 

Key Tradeoffs

1. Your contributions are limited.  Currently in 2009, you may only contribute $5,000 and if you are over 50 you can contribute an additional $1,000 for a “catch-up” provision.  Depending on your income, you might be phased out of your contributions.  For example, a couple making between $166,000 and $176,000 will have their contributions limited.  Income over $176,000 disqualifies you for Roth contributions altogether.  Try this online calculator to determine how much you can contribute to a Roth.

2. You still might have to pay taxes on non-qualified distributions.  In order to meet the specifications for a qualified distribution, you must have had the Roth opened for at least five years and meet one of the following:

• Reached age 59 1/2 by the time of the withdrawal
• Withdrawal is due to qualifying disability
• Withdrawal is made for first-time homebuyer expenses (up to $10,000) 

Again, you are still able to withdraw your contributions at any time without penalty or taxes.

3. Tax treatment differs depending on the state.  The tax laws mentioned above correspond to federal law.  Your state may have differing laws for Roth IRAs You should check with your tax advisor to ensure you won’t have to pay state taxes. 

How Do I Get One?

You can open a Roth IRA through any financial institution, bank, life insurance or mutual fund company or even right online through a brokerage website.  Where you establish one primarily depends on your own needs and preferences.  There are many investment options available as well, so consider the types of investments that will suit your needs (i.e. stocks, funds, CDs, ETFs etc).

Contributions must be made by the time you file your tax return. So in essence you have until April 15 of the following year to get your Roth contributions in for the previous tax year. 

The Roth IRA can be a great investment and retirement savings vehicle for many people.  Be sure to do your homework, develop a plan, assess your needs and be comfortable with your decision.