This is that time of the year when everyone is working on their tax returns. Since IRA contributions might affect how much taxes you pay and how much you can save, today I will be discussing what an IRA is? Who
can contribute to a Traditional IRA? How much can you invest each year? Are the
contributions tax deductible? When can you take money out? What are the
benefits? Advantages and Disadvantages of IRA accounts and so much more!
O.K. so let’s get started!
What is IRA?
An IRA stands for Individual Retirement Account. If
you work, you probably have a 401k plan at work. If you don’t have a retirement
plan at work, then you can set up an IRA retirement account yourself.
With an IRA you can pay less tax on either the
contributions or your earnings. Without a Traditional IRA your investments can
get taxed on both.
You probably also came across a Roth IRA. What is
it? I’ll explain
Both Traditional and Roth IRAs provide generous
tax breaks. But it’s a matter of timing when you get to claim them. Traditional
IRA contributions are tax-deductible on both state and federal tax returns for
the year you make the contribution; withdrawals in retirement are taxed at
ordinary income tax rates. Roth IRAs provide no tax break for contributions,
but earnings and withdrawals are generally tax-free. So with Traditional IRAs,
you avoid taxes when you put the money in. With Roth IRAs, you avoid taxes when
you take it out in retirement.
In this article, I we will
mainly talk about Traditional IRA. Now, let’s see who
can contribute to a Traditional IRA?
First rule, if you are
younger than 70 1/2 then you can
contribute to IRA. If you have
taxable compensation during the year-such as salaries, wages, tips, bonuses,
commissions, and self-employment income-you’re eligible to contribute to an
IRA. You can contribute an amount equal to your taxable compensation up to
$5,500 (or $6,500 if you’re age 50 or older) in 2018.
Now, comes the most
awaited question. How much of your IRA contribution is tax deductible?
And the answer is – it depends:
- Your deduction may be limited if you (or your spouse, if you are married) are covered by a retirement plan at work and your income exceeds certain levels.
Here is the table that illustrates the deductions in this case:
If you're covered by a
retirement plan at work, use this table to determine if your modified AGI affects the amount of
your deduction.
If Your Filing
Status Is...
|
And Your Modified
AGI Is...
|
Then You Can
Take...
|
single or
head of household |
$63,000
or less
|
a
full deduction up to the amount of your contribution
limit.
|
more
than $63,000 but less than $73,000
|
a
partial deduction.
|
|
$73,000
or more
|
no
deduction.
|
|
married filing jointly or qualifying widow(er)
|
$101,000
or less
|
a
full deduction up to the amount of your contribution
limit.
|
more
than $101,000 but less than $121,000
|
a partial deduction.
|
|
$121,000
or more
|
no
deduction.
|
|
married filing separately
|
less
than $10,000
|
a
partial deduction.
|
$10,000
or more
|
no
deduction.
|
|
If you file separately and did not
live with your spouse at any time during the year, your IRA deduction is
determined under the "single" filing status.
|
||
- Your deduction is allowed in full if you (and your spouse, if you are married) aren’t covered by a retirement plan at work.
If
you're not covered by a retirement plan at work, use this table to determine if
your modified AGI affects the amount of
your deduction.
If Your Filing
Status Is...
|
And Your Modified
AGI Is...
|
Then You Can
Take...
|
single, head of household, or
qualifying widow(er)
|
any amount
|
a full deduction up to the amount of your contribution
limit.
|
married filing
jointly or separately with
a spouse who is not covered by a plan at work
|
any amount
|
a full deduction up to the amount of your contribution
limit.
|
married filing
jointly with a spouse
who is covered by a plan at work
|
$189,000 or less
|
a full deduction up to the amount of your contribution
limit.
|
more than $189,000 but less than $199,000
|
a partial deduction.
|
|
$199,000 or more
|
no deduction.
|
|
married filing
separately with a spouse
who is covered by a plan at work
|
less than $10,000
|
a partial deduction.
|
$10,000 or more
|
no deduction.
|
|
If you file
separately and did not live with your spouse at any time during the year,
your IRA deduction is determined under the "single" filing status.
|
||
So,
to sum it up
·
If you do have a work-related retirement account, you can still
deduct your contributions as long as your AGI (Adjusted Gross Income) is below
a certain amount. For 2018, if your AGI is below $63,000 for an individual and
below $101,000 for married couple filing jointly you can deduct your
contributions on your taxes. These amounts are subject to change. Make
sure you always check the limits and regulations to make sure you have the most
updated information. I have a link to my blog under the video with more details.
Feel free to check it out!
·
If you do have a
work-related retirement account, there is a phase-out limit for making
deductible contributions. If you are married and are filing jointly and have an
AGI above $189,000 or more than the deduction of your contributions is
completely phased out.
Now, let’s talk about When You can Take Money Out of an IRA account?
You can withdrawal or take a distribution from
your Traditional IRA at any time. It’s so important that you know the
rules regarding distributions from a Traditional IRA.
·
If
you are OVER the age of 59.5: Your full distribution will be taxed as ordinary income for the
year in which you take the distribution.
·
If
you are UNDER the age of 59.5: Your full distribution will still be taxed as ordinary income
for the year you take the distribution BUT you will also be taxed a 10%
penalty.
This is one of the most important things I
want you to remember with a Traditional IRA. If you decide to take a
distribution before you are 59.5, not only will you be paying regular income
taxes on the full distribution amount but you will also pay a 10% penalty for
taking an early distribution. I would never recommend you take distributions
from your Traditional IRA before age 59.5.
There are exceptions to this rule, and I will
address it in a separate article.
So, really what are the benefits of an IRA?
Well, one of the obvious reasons of investing
money in the IRA is that you create a pension fund for your retirement. The
money grows tax free. Another advantage is that the amount that you invest each
year can be a tax deduction.
Let’s also look at some disadvantages of IRA
-
Since the IRA is a retirement investment
there are certain rules. For one, you can’t take out any money until you are 59
and ½ . If you take a distribution before this age, you will pay a penalty of
10% + tax on ordinary income
-
Also, once
you reach the age of 70 and ½ you are required to take distributions whether or
need the money or not.
-
Distributions are taxed, so if your tax bracket in retirement will
be higher or if the tax law changes unfavorably, then your distributions will
be taxed at a higher rate
So,
to sum it up the advantages are obvious. The main goal of setting up an
individual IRA account is to save money for retirement. Besides, when you deposit money into your IRA, you reduce your
taxable income by the same amount during your working years.
If you are
self-employed you might want to check out our article about SEP IRA –
specifically designed for those individuals that are self-employed!
Disclaimer:
This material is provided for general and educational purposes only; it is not intended to provide legal, tax or investment advice. All investments are subject to risk. We recommend that you consult an independent legal or financial advisor for specific advice about your individual situation.
The tax information herein is not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding tax penalties.
Neither this blog, nor its affiliated companies or representatives provide tax or legal advice. Please consult with your tax and legal advisors regarding your individual situation.
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