The Holidays are now significantly behind us and hopefully you are again focusing on your financial health after the over-indulgence that usually happens around that time. Your Individual Retirement Account (IRA) is a great place to start if you are ready to “get healthy” for the New Year!
There are two types of IRA accounts, the Traditional IRA and the Roth IRA. They each have distinct pros and cons, but both are attractive vehicles for retirement saving since they both offer tax deferral features, albeit different features.
The Traditional IRA
This is the classic example that most people are comfortable and familiar with. First, to be able to contribute you must have earned income and be under age 70 ½. Contributions are tax deductible (or partially deductible) in the year they are made, and the money within the account grows tax deferred until withdrawn.
Contribution limits for 2012 are $5000 and for 2013 will increase to $5500 or your total amount of earned income, whichever is less. In addition those individuals age 50 and older can take advantage of a “catch-up” contribution of an additional $1000, or again up to their level of earned income.
If you and/or your spouse are not an active participant in a retirement plan like a 401(k) or pension plan from your employer then participation in a Traditional IRA is not an issue. If you are an active participant in such a plan, then you aren’t necessarily excluded from contributing to a Traditional IRA but the rules get a little more muddied depending on several factors. We are dealing with the Federal Government and the IRS tax code and putting it all in this article would be long, boring and cumbersome to say the least. Consult with your financial advisor, accountant, or contact me and I would be happy to help guide you so you can determine your situation. If neither spouse is an active participant then each can contribute $5000 to an IRA even if one doesn’t have any earned income. This spousal IRA may even be possible if the one earning income is an active participant at a plan at work, subject to a phase out which begins at an adjusted gross income of $173,000 for 2012.
In contrast to the Traditional IRA; the Roth IRA is basically a mirror image. Contributions are not tax deductible and therefore come from after-tax money; however the growth of the money within the account and the distributions from the account are tax free.
Eligibility for a Roth IRA contribution is subject only to the earned income requirement as noted above and Annual Income limitations. For 2012 contributions those limitations start at a modified adjusted gross income of $125,000 for single filers and $183,000 for married couples filing jointly. You can find the full contribution tables for 2012 here and for 2013 here.
Because of the after tax nature of contributions and tax free distributions of the Roth IRA you can contribute to your account past age 70 ½ as long as you are alive and have earned income.
Q: Can I contribute to both a Traditional and Roth IRA in the same year?
A: Yes, however the limits as to how much you can put into account is for all accounts combined ($5000 for 2012 and $5500 for 2013). So in other words assuming you meet requirements for a full contribution for each type of account you could put $3000 into a Traditional IRA and $2000 into a Roth for your 2012 contribution. You could not put $3000 into one and $3000 into another.
Q: What is defined as earned income?
Earned income includes salaries, fees, bonuses, and commissions for services performed as well as taxable alimony and K-1 income from a partnership.
Q: Can I make a non-deductible contribution?
A: Yes, individuals who are not eligible for an IRA deduction due to being active in a retirement plan through work or who earn too much money, as examples, can still contribute to an IRA. However they will receive no tax deduction on that contribution. Growth of the money in account will still be tax deferred. When it comes time to take distributions from the account, only the earnings are taxed, not the original contribution amount.
Q: When am I eligible to take money out of the account?
A: Penalty free deductions from any IRA begin at age 59 ½. Traditional IRA distributions would be subject to income tax. A Roth IRA distribution at this point would not be subject to any tax if the Roth had been in place for at least 5 years.
For a Traditional IRA distribution prior to this age, any deductions are subject to not only income tax but also a 10% penalty. For a Roth IRA distribution prior to age 59 ½ contributions you made are taken out first, without tax or penalty. Any additional amounts beyond that is considered a return of earnings which will have a 10% penalty and be subject to income tax.
And, yes there are ways to begin distributions earlier than 59 ½ without penalty but that is another discussion
Q: Can I still make contributions for 2012?
A: Yes! You have until April 15, 2013 to make a 2012 contribution. In fact you can make your 2012 and 2013 contributions at the same time.
Now is the time to act, don't lose the opportunity to make an IRA contribution for 2012 and potentially reduce your taxes. If you have specific questions about investing, retirement or would like advice on how to manage your Traditional and/or Roth IRA – please do not hesitate to contact me.
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