The Foreign Service Journal, December 2003

20 F O R E I G N S E R V I C E J O U R N A L / D E C E M B E R 2 0 0 3 M any experts suggest that retirees need 70 to 80 per- cent of their pre-retirement income to maintain their standard of living, and even more if they plan to travel or have major expenses. Active- duty Foreign Service personnel have several options for amassing a com- fortable retirement income: the Foreign Service pension, under the old Foreign Service Retirement and Disability System, known as FSRDS, or the new Foreign Service Pension System, FSPS; a Thrift Savings Plan portfolio; and possibly Social Security. All of these buckets of retirement income help address the challenges posed by increasing longevity. But there is one other mechanism employ- ees should bear in mind: contributions to an Individual Retirement Account. Why open an IRA? Investing in an Individual Retire- ment Account allows you to take advantage of time and compounding in a tax-deferred environment. A 25- year-old who contributes $3,000 to an IRA annually through age 65 would have $777,170 on retirement (assum- ing an 8-percent average annual rate of compounding; the actual return will differ). But beginning contributions at age 45, 20 years before retirement, would produce only $137,286 by retirement, assuming the same $3,000 annual contribution and an 8 percent average annual return compounding annually. Thus, waiting is expensive. As with TSP contributions and other savings vehicles, it is not always easy to set aside the money for IRA contributions. But many Foreign Service personnel find that overseas assignments represent an excellent opportunity to do so, both because of fewer temptations to spend and because of hardship, language and danger pay differentials. How much can be contributed annually to an IRA? From 2002 through 2004, the ceil- ing on IRA contributions is $3,000 or 100 percent of earned income, whichever is less. However, the maxi- mum will rise to $4,000 from 2005- 2007, and after 2008, $5,000, which is indexed thereafter for inflation. Besides contributing $3,000 to their own IRA, wage-earners may also contribute up to an additional $3,000 (for a total of $6,000) to their non- wage-earning spouse’s IRA, as long as the combined earned income of both spouses is greater than or equal to the contribution. These maximum contri- bution levels for both a wage earner and his spouse will rise in accordance with the scheduled increases. In addi- tion, those age 50 or older are eligible to make an additional catch-up contri- bution of $500 (for years 2002 to 2005, increasing to $1,000 for 2006 and after) to their own IRA account and a similar catch-up contribution to the IRA account of a non-working spouse who is at least 50 years old. Contributions for a tax year may be made at any time during that same cal- endar year or by the due date for filing your return for that year, not including extensions. For most people, this means that contributions for 2002 must have been made by April 15, 2003. Like TSP contributions, IRA con- tributions are not necessarily tax- deductible (see next section for gener- al guidelines). In all cases, however, IRA earnings grow tax-deferred until withdrawal of the money. The rules governing withdrawal of funds from IRAs are too complex to summarize here; but in general, it is not advisable to take money out of the account prior to retirement age. However, if you need to tap into your account, there may be mechanisms to do so while avoiding or minimizing the early withdrawal penalty. Such with- drawals may be subject to ordinary federal income tax. But bear in mind that even if you avoid penalties, such withdrawals can still significantly diminish the growth of your retire- ment assets. What are the two types of IRAs? Traditional IRAs are available to everyone who has earned income and is younger than 70 1 / 2 at the time of the contribution. The ability to make tax-deductible Investing in an IRA allows you to take advantage of time and compounding in a tax-deferred environment. IRAs and You B Y S TEPHEN H. T HOMPSON FS F INANCES