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Today's IRAs offer even more ways
for your money to grow with higher contribution limits, attractive tax
incentives, and more flexibility to move money between IRAs and
employer-sponsored retirement plans. One of the main questions you
should ask is, “which type of IRA, Traditional or Roth, is the better
choice for me?” Earnings in both types grows tax-deferred (earnings are
not taxed until withdrawn). The main advantage of Traditional IRA is
it's tax deductible feature.
Even though contributions to a Roth IRA is
not tax deductible, earnings in the account are not taxed when withdrawn.
Another benefit of Roth IRA is it's flexibility withdrawal rules.
Annual IRA Contributions
Any person who currently has
earned income is eligible to open and maintain an IRA account. The
amount an IRA holder is eligible to contribute is based on two things:
income and age. The IRA holder can make a contribution to their IRA for
the amount of earned income they have per year up to a maximum of $3,000
or $3,500, depending on their age. If the individual is under 50 years
of age, they are allowed to contribute any amount up to a maximum of
$3,000 per year. If they are between the ages of 50 and 70 1/2, they
are allowed to contribute any amount up to a maximum of $3,500 per
year.
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What is an
earned income or compensation?
This is income that
you have actually worked for — like salary or self-employment
income. It also includes any taxable alimony payments you receive.
It does not, however, include investment income such as interest,
dividends or profits from sales. It also does not include earnings
from pensions or annuities.
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Spousal contributions are also allowed in
an IRA if you are married and are filing a "joint tax return". They
occur when only one spouse has earned income and chooses to make the IRA
contribution for the non-working spouse. These contributions can
possibly be deducted from the individual's modified adjusted gross
income, which will allow the tax on these funds to be deferred.
A child can also contribute to an IRA, as long as he
or she has earned income. It can be opened as a Traditional or Roth IRA,
with the same maximum contribution as for an adult or 100% of
earned income, whichever is less. To establish an IRA for a minor, the
account must be opened and held by an adult, as guardian, in the name of
the minor. While the adult is the individual authorized to perform
transactions on the account, the minor is considered the registered
owner for tax purposes. The final deadline for making prior year IRA
contributions is April 15. For example, a contribution for tax year 2004
may be made up until April 15th, 2005.
Also, it's important to note that
contributions to IRAs are allowed only up to the age of 70 1/2. (Why 70
1/2?. Why not 69, 70, or 71, why 70 1/2?...Because maybe we are dealing
with the U.S. Congress?)
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Maximum Annual Contribution for 2004 |
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Single |
Couples |
$3,000
for 2002-2004
$4,000 for 2005-2007
$5,000 for 2008 |
$6,000
for 2002-2004
$8,000 for 2005-2007
$10,000 for 2008 |
Tax Deductibility:
One of the major deciding factors for taxpayers is whether or
not the IRA gives the investor the ability to deduct the IRA
contribution. Being able to deduct your IRA contribution means that you
get a tax break for the year the contribution is made.
As long as you have earned income and you meet the age requirements, you
can always make a contribution to a Traditional IRA
and the amount you contribute to your Traditional IRA is tax deductible
if you are not participant of a company sponsored retirement
plan.
But, if you or your spouse is enrolled
in an employer sponsored retirement plan, your income level will
determine whether your contribution is tax-deductible. If your income is
too high to qualify for tax-deductible contributions, you still may make
non-deductible traditional IRA contributions. Contributions to Roth IRAs
are never deductible.
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Adjusted Gross Income (AGI) Limits
on
Deductible Contributions to a Traditional IRA for 2002 |
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AGI Limits |
Singles |
Couples |
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Fully deductible |
$34,000 & below |
$54,000 & below |
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Partially deductible |
$34,001- $44,000 |
$54,001- $64,000 |
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Not deductible |
$44,000 & above |
$64,000 & above |
- The AGI limits for fully
deductible contributions increase until the year 2005 to $50,000 for
singles and until the year 2007 to $80,000 for couples.
- Partially deductible
contributions phase out in 2005 at $60,000 for singles and in 2007
at $100,000 for couples.
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Distributions of funds:
Generally, distributions (withdrawal) from a Traditional IRA are treated as ordinary
income and may be subject to income taxes. A distribution taken from an
IRA before the age of 59 1/2 is considered to be an early distribution.
Early distributions are generally subject to a 10% IRS penalty. There
are exceptions to this rule.
This penalty will not apply if the distribution is used for paying
college expenses or for a first time home purchase up to $10,000. You
may also have to pay taxes on the distribution, depending upon whether
the contribution was tax-deductible. You must also begin taking
required minimum distributions (RMD) from Traditional IRA by April 1 of the
year following the year you turn age 70 ½. This means gradually reducing
your IRA balance by taking out money and adding the distributed amount to your income, even
if you are not in need of the funds.
Tax Credit:
Starting with tax year 2002, you may get up to $1,000
in tax credit for contributing to an IRA. The credit is based upon your income (see chart below), and will range from 0 to 50 percent of eligible
contributions. In order to determine your tax credit, multiply the
applicable percentage from the chart below by the amount of your
contributions up to $2,000.
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Adjusted Gross Income (AGI) |
Applicable Percentage |
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Joint Return |
Head of a Household |
All Other Cases |
of tax credit |
| $1 - $30,000 |
$1 - $22,500 |
$1 - $15,000 |
50% (up to $1,000) |
| $30,001 - $32,500 |
$22,501 - $24,375 |
$15,001 - $16,250 |
20% (up to $
400) |
| $32,501 - $50,000 |
$24,376 - $37,500 |
$16,251 - $25,000 |
10% (up to $
200) |
| Over $50,000 |
Over $37,500 |
Over $25,000 |
0% |
Permitted Investments:
Because the IRA is a vehicle tailored for "savings" and more
specifically for retirement savings, the IRS has established rules which
state very clearly what investments are "suitable" and, therefore
"allowable" in an IRA account. Normally, there would be a public outcry
if the government attempted to define, direct, or limit the scope of an
individual's investment choice but since the government grants special
tax privileges for adherence to this policy, and because it generally
makes sense, the public has accepted these restrictions.
The "allowed" investments are:
Stocks, Bonds, Unit Trust, Mutual Funds, Government Securities,
Annuities, Gold & silver Coins minted by the U.S. Treasury, Selling
Covered Calls and Purchasing Puts.
The "disallowed" investments are: Cash Value Insurance
Policies, Term Insurance, Art and Collectibles and The "Purchase" of
call or "Selling" of put Options.
These lists may not be exhaustive due to
the dynamic nature of tax law. However, the salient point is to know
that all investments are not allowed in retirement accounts. Generally,
those excluded tend to be more risky and more speculative, adding an
inordinate amount of risk to an account designed to provide financial
safety and security for post retirement life.
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What is a
custodian?
Funds invested in an IRA can be
moved between "Custodians". A custodian is nothing more than the
company holding your IRA account. Not every company can be a
custodian. Custodians have to meet certain IRS requirements, and
must apply for and be granted approval before it can act as an IRA
custodian on behalf of investors. The process could be long and
arduous, with no guarantee of ever receiving IRS approval.
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Rollover
Contributions/Distributions - A rollover occurs when an IRA holder
removes funds from a tax-sheltered annuity, qualified retirement plan, a
governmental 457(b) plan, or an IRA and then re-deposits the funds into an
IRA within 60 days from the day after the funds become available to them.
An IRA holder may take one distribution per IRA to roll over into another
IRA every 12 months.
IRA Transfer - IRA Transfers do not pass through the IRA account
holder's hands. This type of IRA asset transfer occurs directly between
the custodial organizations. There is no limit on the number of transfers
that can be done each year.
Next-->>
What is a Rollover
IRA?
Related Links:
Financial Calculators:
Table of Contents:
-
What Are Retirement Accounts?
-
Employer Based
Retirement Plans
-
401(k) Plans
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Individual Retirement Accounts (IRAs)
-
Roth IRA
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What is a Rollover IRA?
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Converting and
Recharacterizing of an IRA
-
Education IRA & SEP IRA
-
Self Employed Retirement plan: Keogh
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