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Make the Most Of Your IRA
Individual Retirement Accounts (IRAs): Two Options
There are two primary types of IRAs. The first is a Traditional IRA, which may permit an annual, tax-deductible contribution. The second is a Roth IRA which, while not permitting a tax-deductible contribution, does allow for a tax-free distribution of both contributions and earnings under certain circumstances.
Before you make a decision on which one is right for your situation, you may want to talk to your financial professional.
What Is A Traditional IRA?
A traditional individual retirement account allows your investment earnings to grow tax deferred until withdrawn, typically at retirement. Generally, if you have earned income or receive alimony, you can establish as many IRAs as you want prior to the tax year in which you reach age 70 1/2, provided the total of your contributions doesn't exceed the limits discussed below. You may also have a Traditional IRA even if you participate in a qualified pension, profit-sharing, or other retirement plan. However, if you are an active participant in a qualified plan, your entire contribution may not be tax deductible, depending on your income and tax filing status.
Traditional IRAs offer two distinct advantages in terms of taxes: potential deductibility of contributions and current tax deferral on investment earnings.
Rules On IRA Contribution Limits
You and your spouse can each contribute annually up to $5,000 (for 2008) or 100% of your earned income, whichever is less, into an IRA. In 2008, married couples filing jointly can generally contribute a total of $5,000 ($10,000 per spouse) even if only one spouse had income. These limits apply no matter how many IRAs you have, or if you have both a Traditional IRA and a Roth IRA. That is, the total of your contributions to all IRAs must not exceed the appropriate limit. Also, in 2008, IRA owners aged 50 and older are eligible to make a catch-up contribution of up to $1,000. Like the $5,000 limit, the catch-up of $1,000 applies to whether you have one or more IRA accounts.
In addition, you can open an IRA or make contributions to an existing IRA as late as the deadline for filing a tax return for that year. That means you have until April 15, 2009, to make your 2008 IRA contribution.
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New Income Limits for IRA Deductibility |
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| Tax Year | Joint Filers | Single Filers | ||
| 2008 | $85,000 - $105,000 | $53,000 - $63,000 | ||
Taxpayers who are not participants in an employer-sponsored retirement plan can deduct their IRA contributions up to the specified limit. Taxpayers who participate in employer sponsored retirement plans may not be able to deduct all of their contributions to a Traditional IRA depending on their income. For example, married taxpayers filing jointly, where both participate in their employers' retirement plan may not deduct any portion of their IRA contribution if their adjusted gross income (AGI) for 2008 exceeds $105,000. The amount is pro-rated between $85,000 to $105,000. Below $85,000, their full contribution is tax deductible.
In situations where only one spouse is a participant in a retirement plan, a deductible IRA contribution may be made for the other spouse under a spousal IRA contribution — provided the AGI is below $169,000 (the deduction is prorated between $159,000 - $169,000).
| Possible Benefits of Tax Deferred Compounding |
 As you evaluate the potential benefits of an IRA, consider the advantage of tax deferral. This chart shows the result when a hypothetical $100 monthly investment is made for 30 years in a tax-deferred plan versus the same investment taxed at 25% annually, assuming an 8% average rate of return compounded monthly. If the final tax-deferred amount is withdrawn at retirement and taxed at 25%, it exceeds the taxable final amount by nearly $12,000. |
Change Jobs Without Losing Any Retirement Benefits
IRAs can also come in handy when you're about to leave jobs and need to move your retirement plan assets. If your former employer permits you to withdraw your retirement money, you can move these funds to an IRA account and postpone the payment or move them from your former employer's qualified retirement plan into a rollover IRA and avoid owing current income tax on the distribution.
If you choose to physically receive part or all of your money and do not replace the entire amount within 60 days, you may be subject to an early withdrawal penalty tax and income taxes on the amount you don't rollover to an IRA or other plan. Some exceptions may apply.
Strict Rules On Withdrawals From Traditional IRAs
Generally, any distribution you receive from an IRA before the day you reach age 59 1/2 is subject to a 10% penalty tax imposed by the IRS, in addition to federal and state income tax. Beginning at age 59 1/2, you can withdraw money (of which any deductible contributions and investment earnings are taxable at your then-current income tax rate) from your IRA without penalty, whether or not you are still employed.
Distributions before age 59 1/2 are not subject to the penalty tax under certain circumstances:
- You become permanently disabled.
- You die before age 59 1/2 and distributions are made to your beneficiary or estate after your death.
- You make withdrawals to pay un-reimbursed medical expenses that exceed 7.5% of your adjusted gross income.
- You make withdrawals for a qualified home purchase (lifetime limit of $10,000).
- You make withdrawals to pay qualified higher education expenses for yourself, a spouse, children, or grandchildren.
You must begin withdrawals from your IRA by April 1 following the year in which you reach age 70 1/2. New rules established by the IRS in 2001 simplify the calculation of required minimum distributions. A great advantage of taking only the required minimum distribution is that the balance continues to compound tax deferred. However, if your distributions in any year after you reach age 70 1/2 are less than the required minimum, you will be subject to a penalty tax equal to 50% of the difference.
Your IRA: A Strong Foundation For Your Financial Future
An IRA can become the cornerstone of your personal retirement savings program, providing the foundation for your financial security. That's why it is so important to start planning today. Consult with your financial professional to help you maximize the power of your IRA to help build a more secure retirement.
Points To Remember About Traditional IRAs
- If you have earned income or alimony, you can establish as many IRA accounts as you want prior to the tax year in which you reach age 70 1/2 (subject to a combined limit of $4,000 for 2007).
- Annual contribution limits are $5,000 (in 2008) or 100% of your earned income, whichever is less. Provided a joint return is filed, married couples can contribute a combined total of $8,000 (in 2007). Also, IRA owners aged 50 and older are eligible to make a catch-up contribution of $1,000 in 2008.
- You can open an IRA or make contributions to an existing IRA as late as April 15, of the following year.
- Income limits may restrict the deductibility of contributions for active participants in employer-sponsored retirement plans.
- IRA deductibility is not affected by whether a spouse participates in an employer-sponsored plan or doesn't work.
- You must begin withdrawals from your IRA by April 1 following the year in which you reach age 70 1/2.
- Individuals under the age of 59 1/2 may make penalty-free withdrawals to pay college expenses for themselves, a spouse, children, or grandchildren.
- Consult your tax advisor before making any tax related decisions.
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Common Questions
- Can I avoid the 10 percent penalty tax for early withdrawals from a traditional IRA?
- Can I convert my traditional IRA funds into a Roth IRA?
- Can I set up a traditional IRA?
- I need money--can I take funds from my IRA?
- It's January, and I forgot to contribute to my IRA. Is it too late?
- Should I withdraw money from my IRA to pay for my child's college tuition?
- What are my options if I inherit an IRA or employer-sponsored plan?
- What are required minimum distributions and how are they calculated?
- What are the rules for IRA contributions?
- What's a premature IRA distribution, and what happens if I make one?
- Can I roll a retirement plan distribution into an IRA?
