At one time, there was relatively little confusion about IRAs
because there was only one type available. Now, however, IRAs have
proliferated-there's the "traditional" IRA, which may be funded with
deductible and/or nondeductible contributions, Roth IRA, SEP-IRA, and SIMPLE
IRA. Some of these IRAs have similar features, but others have features that
are unique.
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.
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 on distribution (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contributions aren't taxed when they are withdrawn.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).
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 $5,500 for 2018 ($6,500 if you are age 50
or over in 2018). 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 .
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. 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 2018, you can
contribute up to $5,500 to a Roth IRA for that year ($6,500 if you are age 50
or older in 2018).
Roth IRA contributions aren't deductible. However, earnings are
tax-deferred within the Roth IRA and (unlike a traditional IRA) are tax-free if
certain conditions are met when paid out. And if a Roth IRA payout doesn't meet
these conditions, you're 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 regardless of the amount of your AGI. The amount taken out of the
traditional IRA and rolled over to the Roth IRA is treated for tax purposes as
a regular withdrawal (but it's not subject to the 10% early withdrawal
penalty).
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 contact us for
more information on how you and your family may be able to benefit from IRAs in
all their various forms.
