FUNDING IRA

A question that should be asked more frequently:

Should I fund my IRA every year?

Before making any investment, do your homework. First, ask this question: Will the person telling you to make this investment, profit from it. If the answer is yes, consider the profit motive not just the advice.

Investment salesmen, like used car salesmen, must be weighed with a grain of inquisitiveness. They will give you many good reasons to “buy” their product. Everybody’s Uncle, who makes no commission on your investment, will give you some of the negative aspects of IRAs.

In the 15% tax bracket you save $300 in taxes on a maximum IRA contribution of $2000. If you withdraw the money prematurely (prior to age 59 ½) you face a 10% penalty (with some exceptions) and pay tax on the withdrawal in the year taken. This example assumes a 28% tax bracket and premature withdrawals with no special treatment.

Let’s say you make an IRA contribution of $2000 at age 20. Three years later you moved from the 15% bracket to the 28% bracket and make a $2000 premature withdrawal:

You save $300 in the year of contribution, but pay a $200 penalty and $560 income tax in the year of withdrawal. In this situation, you save $300 but lose $760 -- a net loss of $460 plus applicable commissions, fees and expenses.

Think twice before making an IRA contribution if you in the 15% tax bracket. You may NEVER be in a lower tax bracket; so it is pay (at the lower rate) now or pay (at perhaps a higher rate) later.

Many IRA dollars are invested in mutual funds where growth results from capital gains.

[Example of a CAPITAL GAIN: You buy 100 shares of “stock” for $2000. You sell it for $3000. Your CAPITAL GAIN is $1000. For the purpose of this example all “CAPITAL GAIN” is LONG TERM. LONG TERM refers to items sold after being held longer than one year.]

A $1000 CAPITAL GAIN earned outside an IRA incurs a maximum tax of 20%.

Tax on $1000 CAPITAL GAIN = $200.

All IRA withdrawals, no matter how earned, are considered “income” and taxed as such.

The same $1000 CAPITAL GAIN withdrawn from an IRA incurs a 28% tax and a 10% penalty.

Tax on withdrawal = $380

Effectively, CAPITAL GAINS are taxed at a higher rate when withdrawn from an IRA.

Young IRA contributors must lock up their assets for decades or face a 10% penalty. EU’s life experience includes too many examples of premature withdrawals when financial priorities change between ages 20 and 60. Before placing assets in penalty status, consider the advantages and disadvantages. IRA rules change, tax rules change, tax rates are trending up, capital gains rates are trending down. Print this page and present it to your investment professionals. If they find any inaccuracy, please forward source.

--Everybody’s Uncle--