An Individual Retirement Account (IRA) is a great retirement savings tool for most
individuals. Created by the federal government, IRAs can be funded during your
working years. During retirement, IRAs may help supplement your Social Security benefits. Your retirement savings can begin with your annual IRA contribution.
If you are under age 50, the current maximum annual contribution amount is $5,000. For those 50 years and older, an additional $1,000 can be contributed. If turning 50 this year, you are now eligible to contribute $6,000. The contribution amounts are adjusted for inflation each year by the federal government.
IRAs come in two types: Traditional and Roth. To determine which one is best suited for your annual contribution, here are some key factors to consider:
Advantages to a Traditional Deductible IRA:
- Tax Deductible: Your contribution is deductible on your federal
income tax return for the year in which you contribute.
- Tax-Deferred Growth: Your contribution grows tax deferred
until you withdraw the money. This means you do not pay any taxes while
your money is growing.
Limitations to a Traditional Deductible IRA:
- Adjusted Gross Income (AGI) Limitations: The amount you can deduct is limited based on your AGI and if you participate in your employer sponsored
retirement plans. Your contribution may be fully deducted on your income
taxes, partially deducted or not deductible at all.
- 10 Percent Penalty: The 10 percent penalty is used to encourage IRA owners to keep their money in their IRA until reaching age 59 ½. If you withdraw any of your money prior to age 59 ½, then you will incur a 10 percent penalty on your withdrawal amount. There are some exceptions to the rule: educational expenses, first time home purchase and certain medical
Advantages to a Roth IRA:
- Avoid Taxes in the Future: Roth IRAs grow tax free. Therefore no taxes are due when you withdraw your money.
- No Required Minimum Distributions (RMD): Roth IRAs do not require RMDs after age 70 ½, so your money can continue to grow with the potential for larger dollar amounts to leave to heirs.
Limitations to a Roth IRA:
- Adjusted Gross Income (AGI) Limitations: For high wage earners (2011 limits
for single filing over $122,000 and married filing jointly over $179,000),
Roth contributions are not allowed.
- Disqualified Distributions: The earnings in your Roth must remain in the account for 5 years (known as the 5 year clock) and until you reach 59½ years old. A 10 percent penalty will be applied on earning distributions that do not meet these requirements.
Always consult a financial planner or IRS publication 590 before you make your final IRA decision. Making the correct IRA choice now can benefit you down the road in your retirement.