What You Can Do If Your Texas Employer Does Not Offer a 401(k)

If your Texas employer does not offer a 401(K) plan and you are looking to invest for retirement while reducing your current tax burden, consider a traditional Individual Retirement Arrangement, more commonly known as a traditional IRA.

The IRA was created by Congress in 1964 as part of the Employee Retirement Income Security Act of 1974 (ERISA). As of 2014, annual contributions to an IRA account are capped at $5,500 for individuals age 49 and younger and $6,500 for individuals 50 and above.

Advantages

The most important advantage of an IRA is the ability to make an “above the line” deduction of those contributions in an individual’s annual income tax filing. This means that if certain conditions are met, the reported adjusted gross income (AGI) is reduced by the contribution amount. A reduced AGI has several benefits.

First, student loan borrowers making payments on an income based or income contingent repayment plans will reduce their monthly payment, since it bases income on the AGI the payer reported to the IRS.

Second, reducing AGI may make one eligible for additional tax deductions, such as the student loan interest deduction, that are often phased out or eliminated at higher income levels. Third, a reduced AGI may reduce one’s marginal income tax rate.

Protection

Another key advantage of the IRA is the ability to protect assets from private creditors, provided that the account is not listed as collateral when the loans are established in Texas areas. It is also more difficult for private creditors to place a lien on IRA holdings.

In addition, up to $10,000 can be withdrawn without incurring the normal 10% early withdrawal penalty if used towards a first-time home buying expense, eligible medical bills, during disability, for payment of IRS levies, and if used for other permissible expenses . Finally, unlike the Roth IRA, individuals of all income levels may make annual IRA contributions.

Before investing in an IRA, also consider its disadvantages.  First, deferred taxation does not necessarily mean reduced taxation. All withdrawals, not just gains, are subject to taxation, Also, current US effective tax rates are some of the lowest in the modern era. Those rates may go up in the future, when withdrawals occur.

Those withdrawals will then be subject to potentially higher tax rates at that time. While the Roth IRA selects current tax rates over future tax rates, the traditional IRA does the opposite.

Second, IRS requires mandatory withdrawals after 70 and ½ years of age. Third, early withdrawals are subject to both taxation and a 10% early withdrawal penalty.

Borrowing

Borrowing from an IRA is prohibited and will still result in the 10% penalty. Fourth, taxable income at the time of retirement may result in a reduction or elimination of means-tested benefits, such as food stamps and housing vouchers, often available to senior citizens with limited income. Finally, unlike with private creditors, an individual’s IRA holdings are not exempt from collection by government creditors, like the IRS.

Remember that this article is for informational purposes only. Always consult an attorney or your financial advisor (or both) before making any investment decisions.

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