There
are many different IRAs, including the regular IRA, which may be funded with
deductible and/or nondeductible contributions, Roth IRA, SEP-IRA, and SIMPLE IRA.
What do all these IRAs have in common? They can help you and your family save
significant amounts for retirement on a tax-favored basis. Here's an overview
of the different types of IRAs available today.
Traditional
IRAs
Traditional
IRAs can be funded with deductible and nondeductible contributions.
Deductible IRA contributions. You can make an annual deductible
contribution to an IRA if:
(1) you (and your
spouse) are not an active participant in an employer-sponsored retirement plan,
or
(2) you (or your
spouse) are an active participant in an employer plan, and your modified
adjusted gross income (AGI) doesn't exceed certain levels that vary from
year-to-year by filing status.
For example, in 2006, if you are a joint return filer covered by
an employer plan, your deductible IRA contribution phases out over $75,000 to
$85,000 of modified AGI.
If you're single or a head of household in 2006, the phaseout
range is $50,000 to $60,000. For a married filing separately, the phaseout range is $0 to $10,000 (for all years). If you are
not an active participant in an employer-sponsored retirement plan, but your
spouse is, your deductible IRA contribution phases out
with modified AGI of between $150,000 and $160,000.
Deductible
IRA contributions reduce your current tax bill, and earnings within the IRA are
tax-deferred. However, every dollar you take out is taxed in full (and subject
to a 10% penalty if you withdraw money before age 59-1/2, unless one of several
exceptions apply). You must begin making minimum withdrawals by April 1 of the
year following the year you attain age 70-1/2.
Nondeductible IRA contributions. You can make an annual nondeductible IRA
contribution without regard to your coverage by an employer plan and without
regard to your AGI. The earnings in a nondeductible IRA are tax-deferred within
the IRA, but are taxed (and subject to a 10% penalty if you withdraw money
before age 59-1/2, unless one of several exceptions apply).
You
must begin making minimum withdrawals by April 1 of the year following the year
you attain age 70-1/2. Nondeductible contributions aren't taxed when they are
withdrawn. If you've made deductible and nondeductible IRA contributions, a
portion of each IRA distribution is treated as coming from nontaxable IRA
contributions (and the rest is taxed).
NOTE: If you can't make a deductible
contribution to a traditional IRA, you should contribute (if eligible) to a
Roth IRA instead of making a nondeductible contribution to a traditional IRA.
That's because the Roth IRA offers a better package of tax benefits than you'd
get by making a nondeductible contribution to a traditional IRA.
Deductible
and nondeductible IRA limits. The maximum annual IRA contribution (deductible or nondeductible,
or a combination) is $4,000 for 2006 ($5,000 if you are age 50 or over in 2006).
Additionally, your IRA contribution for a year (deductible or not) can't exceed
the amount of your compensation includible in income for that year. Deductible
and nondeductible IRA contributions can't be made once you attain age 70-1/2.
IRAs
often are referred to as “traditional IRAs” (or “regular IRAs”) to distinguish
them from Roth IRAs.
Roth
IRAs.
You
can make an annual contribution to a Roth IRA if your AGI doesn't exceed
certain levels that vary by filing status. For example, if you are a joint return
filer, the maximum annual Roth IRA contribution phases out between $150,000 and
$160,000 of modified AGI ($95,000 to $110,000 for single taxpayers). Annual
contributions to Roth IRAs can be made up to the amount that would be allowed
as a contribution to a traditional IRA, reduced by the amount you contribute
for the year to non-Roth IRAs, but not reduced by contributions to a SEP IRA or
SIMPLE IRA (see below). For example, if you don't contribute to a traditional
IRA in 2006, you can contribute up to $4,000 to a Roth IRA for that year
($5,000 if you are age 50 or older in 2006).
Roth
IRA contributions aren't deductible. However, earnings are tax-deferred within
the Roth IRA and (unlike a traditional IRA) are tax-free if paid out (1) after
a five-year period that begins with the first year for which you made a
contribution to a Roth IRA, and (2) once you reach age 59-1/2, or upon death or
disability, or (up to $10,000 lifetime) for first-time home-buyer expenses of
you, your spouse, child, grandchild, or ancestor. However, if a Roth IRA payout
doesn't meet these dual conditions, you will be treated as first withdrawing
nontaxable Roth IRA contributions; the balance (representing earnings) is taxed
and is subject to a 10% penalty for pre-age-59-1/2 withdrawals, unless one of
several exceptions apply. Thus, for example, if you
contribute $6,000 over the years to Roth IRAs and withdraw $9,000 at age 55 to
buy a boat, only $3,000 is taxed (and is subject to
the 10% penalty).
You
can make Roth IRA contributions even after you attain age 70-1/2 (if you have
sufficient compensation income), and you do not have to take minimum
distributions from a Roth IRA after you attain that age. That makes Roth IRAs
an excellent wealth-building vehicle for your family.
You can
“roll over” (or convert) a traditional IRA to a Roth IRA in a year that your
AGI, as specially computed, doesn't exceed $100,000, but the amount taken out
of the traditional IRA is treated for tax purposes as a regular withdrawal (but
it's not subject to the 10% early withdrawal penalty). Beginning in 2010, the $100,000 AGI ceiling
on conversions from a traditional IRA to a Roth IRA will be removed.
SEP
IRAs and SIMPLE IRAs
Small
businesses that want to provide employees with a retirement plan, but keep
administrative costs low, may be able to set up a SEP (simplified employee
pension) or SIMPLE (savings incentive match plan for employees) plan. In either
type of plan, contributions are made to IRA-type accounts in the employees'
names. Annual contributions to these plans are controlled by special rules and
aren't tied to the normal IRA contribution limits. Distributions from a SEP IRA
or SIMPLE IRA are subject to tax rules similar to those that apply to
deductible IRAs.
Income
tax credit for contributions to IRAs
If
your adjusted gross income doesn't exceed specified levels, you may be entitled
to a credit (saver's credit) against your income tax equal to a percentage of
your contribution to any of the above IRAs. If you are entitled to the credit,
you get it in addition to any deduction you may be entitled to for the same
contribution.
Please
call our office for more information on how you and your family may be able to
benefit from the various forms of IRAs.