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Understanding your options with IRAs

March 13, 2002

Investors always feel better during a decent market rally. Last week the Dow Jones Industrial Average posted its’ biggest one-day gain in months (262 points) and lifted the average to its highest level since August 27, 2001. All sectors of the market participated in last week’s rally propelled by more good news on the economic recovery. Our analyst expects the current rally to continue, but also expect pullbacks.

    There are many signs that point to a stronger economy. Chairman of the Federal Reserve Dr. Alan Greenspan told the Senate Banking Committee that the economic slowdown might be over. In fact, he told Senators that an expansion might be well under way - however it would probably be far more gradual than previous recoveries. Dr Greenspan expects the economy to grow 2.5% to 3% this year. The major economic indicators are strengthening and the most recent unemployment report was stronger than consensus forecast. The Senate passed the $51 billion fiscal stimulus bill passed by the House earlier. President Bush is expected to sign it. The package extends jobless benefits and has tax breaks for business, but will spur additional treasury debt sales. 

    Investors are hoping interest rates will begin to rise; of course businesses and consumers like the low interest rates on debt.  There are some investment grade corporate bonds that are trading at very attractive yield spreads to the treasury market. Recently GMAC bonds were available with a 6.125% coupon, maturing 02/01/07. The GMAC debt carries an A2 rating by Moody’s and a BBB+ by Standard & Poor’s. Our analyst expects the spread to narrow considerably in the next year as we see further evidence of a strengthening economy.

    Tax time is quickly coming to an end; April 15th will be here before we know it. Have you considered funding your 2001 Individual Retirement Account (IRA)? Remember, retirement will sneak up as fast as April 15th so consider contributing to your retirement consistently and hopefully you can start at a young age. Taxpayers age 50 and older will be able to make additional contributions to their plans beginning in 2002. The special 50 and over limit will be an additional $500 in 2002 and $1000 per year in 2003 and thereafter. Here are your options for IRAs:

    Traditional IRA’s – Traditional IRA’s continue to offer tax-deductible and tax-deferred accumulation of earnings. There are more ways to access your money without penalty. Also, higher income limits preserve the tax deduction for more taxpayers.

    Regardless of your income, you can contribute up to $2000 for 2001 and $3000 for 2002 of earned income per taxpayer each year to Traditional IRAs.  If neither you nor your spouse is actively involved in an employment-based retirement plan, your contributions are fully tax-deductible. If one of you has a retirement plan, your contributions may be fully or partially deductible, depending on your income. The income limits that determine deductibility will increase annually through 2007.

    Previously, distributions were subject to a ten percent penalty if withdrawn before 59½ except in the event of your death, disability or other qualifying reasons. Now you can also withdraw a lifetime total of $10000 without penalty to buy a first home. Additional funds may be used to pay for higher education for yourself or for your spouse, children or grandchildren. Amounts withdrawn for college can pay for tuition, books, supplies, equipment and room and board.

    ROTH IRAs – The Roth IRA offers tax-free accumulation of investment savings. You can put your savings in a Roth IRA, or use this investment in a combination with Traditional and Educational IRAs. Roth IRA funds may be withdrawn at anytime; if the Roth contributions are withdrawn there is no tax consequence. If earnings are withdrawn there must be a “Qualified Distribution” for it to be a tax and penalty free distribution of the savings. A Qualified Distribution must be made after the funds have been in the account for 5 years and after you reach the age of 59½, or death, or disability or the first time home purchase ($10000 lifetime).

    If you have earned income you can continue to make contributions to a Roth IRA after age 70½, the cutoff for Traditional IRA deposits. 

    You are allowed to contribute up to $2000 (single) or $4000 (joint) of earned income to a Roth IRA for tax year 2001 if your adjusted gross income is less than $95,000 (single) or $150,000 (joint).  The contribution limits will increase to $3000 (single) or  $6000 (joint) in 2002.  Contributions are not tax-deductible but remember they grow tax-free. You can roll over contributions from existing Traditional IRAs into Roth IRAs without a ten percent penalty although rollovers are subject to income tax. 

    If you contribute to both a Traditional IRA and a Roth IRA in any year, the maximum combined contribution is $2000 (single) for 2001 and $3000 (single) for 2002.

    Both types of IRAs have advantages - the most important point to remember is you need to start saving for retirement. Traditional IRAs offer the tax deduction as an incentive to put money away; the Roth IRA offers tax-free growth, no tax liability upon retirement and access to your contribution.

    It is always best to consult with your personal tax advisor about the specific tax consequences and advantages for your situation. One key to success is to spend less than you make and make wise investments.

        Nancy Hadley is an Investment Representative with D.A. Davidson in Sandpoint


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Nancy Hadley

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