Did you know that you could earn no income and still contribute up to $4,000 ($5,000 if you are over 50) to an IRA in 2007?

With a “Spousal IRA,” if either spouse has earned income during the year, both spouses may be able to use the income to fund their own IRA. Even if the income earner has a company sponsored retirement plan, the other spouse may fully contribute to an IRA.

The only limitation with a spousal IRA is that the Modified Adjusted Gross Income (MAGI) on the joint tax return must be less than $156,000 to be fully deductible. The IRA is partially deductible if the MAGI is between $156,000 and $166,000.

If you or your spouse have little or no income in 2007, consider contributing to an IRA. As long as your joint income exceeds the total amount contributed to both of your retirement accounts and your MAGI is below the maximums mentioned above, you may fully fund and IRA with no personal income.

Thanks to the present financial crisis that began with the proliferation of “sub-prime” mortgages, housing prices are dropping and mortgages are getting harder to obtain, even for people with a good credit history. If you are wondering if you will ever be able to buy your first home, you may want to consider the benefits of saving for it by using a Roth IRA.

If you are single, with an Adjusted Gross Income (AGI) of under $99,000, or married (filing jointly) with an AGI of under $156,000, you may contribute up to $4,000 of your income to a Roth IRA. In 2008, the maximum Roth IRA contribution will be $5,000. While your contribution does not lower your immediate taxes owed, it can literally open the door to owning your first home.

Let’s assume that you would like to buy a house in the next 5 years. In 2007, you contribute $4,000 to a Roth IRA. In 2008 -2011, you contribute $5,000 each year. At the end of 5 years, assuming an 8% return on your Roth IRA investments, the $24,000 that you have invested will have grown to over $30,000.

With a Roth IRA that has been established for at least five years, you are allowed to withdraw up to $10,000, in income and growth, plus all of your contributions, when the proceeds are used to buy a first home. In the example above, all $30,000 can be withdrawn to purchase a first home, without any income tax or penalties.

This approach will allow you to make a 10% down payment on a $300,000 house. If the remaining $270,000 is financed with a 30 year mortgage with a 6% annual interest rate, your monthly payments would be approximately $1,620 (plus taxes and insurance). While this approach takes patience, it may allow you to become a home owner, building up equity in your future, while your friends are still renting.

I am often asked whether it is better to contribute to a traditional, deductible IRA or to a Roth IRA. As with most personal finance questions, my answer is typically “it depends.” In this entry, I will provide some guidelines to help you decide which is best for you.

When I use the term “IRA,” I am only addressing deductible IRAs. In a future entry I will discuss why I believe that it is seldom wise to fund a non-deductible IRA.

Let’s first look at the rules:

With a traditional IRA, you must be under 70½ years old plus you and/or your spouse must have earned income. In 2007, your maximum contribution is the lesser of $4,000 ($5,000 if you are over age 50) or the total amount that you and/or your spouse earned. If you are covered by a retirement plan, you can only deduct the full amount contributed to your IRA if your Modified Adjusted Gross Income (MAGI) is no more than $52,000 as a single tax payer or $83,000 as a joint filer.

With a Roth IRA, your Adjusted Gross Income (AGI) must be less than $99,000 as a single filer or $156,000 as a joint tax filer plus you and/or your spouse must have earned income. In 2007, your maximum contribution is the lesser of $4,000 ($5,000 if you are over age 50) or the total amount that you and/or your spouse earned. If you make any deductible IRA contributions, the amount that you can contribute to a Roth IRA is further reduced by the amount that you contributed to the deductible IRA.

Based on these rules, the decision on which IRA to use is sometimes obvious:

1. If you are a single filer with an AGI over $99,000 or a joint filer with an AGI over $156,000 and you are not covered by a retirement plan, you can only fund an IRA.
2. If you are covered by a company retirement plan and your MAGI is over $83,000 but less than $156,000 as a joint filer or $56,000 but less than $99,000 as a single filer, you cannot receive full IRA deductibility, but you are able to fully fund your Roth IRA.
3. If you are over 70 ½ and have earned income, you can only fund a Roth IRA.
4. If you are saving to buy your first home, up to $10,000 of growth and income from a Roth IRA, plus all of the contributions may withdrawn, tax and penalty free.

Now let’s look at the more subtle differences between the IRA plans:

1. If you are under 40, the tax free growth combined with the tax free withdrawal of the funds (when you are over 59½) often make the Roth IRA a better, after-tax investment strategy.
2. If you may need some of the funds before you turn 59½, with a Roth IRA you can typically withdraw all of your contributions and pay no taxes or penalty on the withdrawal.
3. If you are over 40 and wish to pass some of your estate to your children, a Roth IRA is an excellent way to pass funds to younger generations.

When none of the above apply, the decision of funding a Roth IRA or a traditional, deductible IRA must be made by analyzing your current tax bracket, what you believe will be your future (retirement years) tax bracket and whether you expect to consume the retirement funds or pass them to future generations. This is never easy and often comes down to whether you want the tax reduction now or you can wait to get it later.