With IRAs, Earlier Is Better

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. That means contributions for this year's IRA can be made as late as April 15 of next 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% 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. "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.

For the 2000 tax year, singles who earn $32,000 can make fully deductible IRA contributions, and they can make partly deductible contributions until their income hits $42,000. Married couples with up to $52,000 in income can make fully deductible contributions. Partially deductible contributions are allowed until joint income reaches $62,000.

The income limits rise by $1,000 in 2001 and 2002. In 2003, a single will be able to make a fully deductible contribution with income of $40,000, with partly deductible contributions until $50,000. The phase-out limits for married couples will be $60,000 to $70,000 for joint filers. By 2007, the phase-out limits will be $50,000 to $60,000 for singles and $80,000 to $100,000 for joint filers.

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.

IRA Eligibility

* Anyone with earned income may contribute to a regular individual retirement account.

* Contributions may be deductible if the taxpayer is not an active participant in a workplace retirement plan or if the taxpayer's adjusted gross income is below certain limits.

* Roth IRA contributions, which are never deductible, are preferable to making a non-deductible IRA contribution but are limited to taxpayers with income below certain limits.