An IRA, or Individual Retirement Arrangement, is a savings plan for retirement open to all taxpayers who have earned income during the year. As long as earnings on an IRA are not withdrawn, they are not subject to taxes. However, contributions to an IRA are limited to a combined total of $5,500 per year per taxpayer for those younger than 50 or $6,500 per taxpayer for those who are 50 or older.
Retirement Contribution Credit
In addition to any IRA deductions you claimed on your tax return, if you’re a taxpayer with a modified adjusted gross income of up to $61,000 (if Married, Filing Jointly), up to $45,750 (if Head of Household), and up to $30,500 (for all other filing statuses), you may qualify for a credit of 50%, 20%, or 10% on the first $2,000 you contributed to a retirement savings plan.
There are several types of IRAs, including:
Deductible Traditional IRA
Nondeductible Traditional IRA
Deductible Traditional IRA
Any distributions from deductible (traditional) IRAs are taxable. You may be eligible to deduct your yearly contribution directly from the income amount on your tax return.
If you are covered by your employer’s pension plan, your yearly contribution is only fully deductible if your modified adjusted gross income does not exceed $61,000. If you are not covered by your employer’s pension plan, your full contribution is deductible from your income, regardless of the income amount.
If you are married and filing a joint return and both of you are covered by a pension plan, your yearly contributions are fully deductible only if your modified adjusted gross income is less than $98,000. For all income amounts exceeding $98,000, the deductible contribution decreases as your income level increases, and eventually is eliminated.
However, if both you and your spouse are employed but one of you is not covered by a pension plan, you’ll have different income limits for fully-deductible contributions to your IRA.
You are required to withdraw the entire balance of your traditional IRA (or begin receiving periodic distributions) by April 1 of the year after you reach age 70½.
You must continue these withdrawals each year until either you die or your IRAs are depleted.
If you are age 70 ½ or older, you may make a tax-free charitable contribution of up to $100,000 directly from your traditional IRA. But, the contribution must be a trustee-to-trustee transfer: the institution that handles your IRA must send the money directly to the charitable organization on your behalf. This direct contribution can be included in your required yearly minimum distribution.
Nondeductible Traditional IRA
Depending on your filing status and your modified adjusted gross income, your traditional IRA contribution may be nondeductible, in full or in part.
Each year you make a contribution to a nondeductible IRA, you must complete a Form 8606 (Nondeductible IRAs) to determine how much of the contribution is taxable.
The Roth IRA is subject to most of the same rules which govern original (traditional) IRAs.
Like traditional IRAs, Roth IRAs allow you to contribute up to $5,500 per year ($6,500 if you’re 50 or older) but you cannot deduct the contribution from your income. Also, like a traditional IRA, your deductible contribution decreases as your income level increases, and eventually is eliminated. This reduction starts when your income exceeds $116,000 (or $183,000 if you’re married and filing a joint return).
Thought qualified Roth IRA distributions are not taxable, early withdrawal will earn you a 10% additional tax like early withdrawal of any IRA.
Did you know you can convert your traditional IRA to a Roth IRA? You can do this any time, and there is no maximum income limitation for conversions. Though the conversion amount is exempt from the aforementioned 10% additional tax, keep in mind that you generally must pay taxes on the full amount of the distribution you convert, except existing nondeductible contributions.
Unlike traditional IRAs, withdrawals from a Roth IRA are not required, ever, regardless of age.
If you’re employed but your spouse isn’t, you may still set up an IRA for each of you and contribute up to $5,500 per year into each IRA (or $6,500 if you’re 50 or older). When calculating your deductible amounts, keep in mind that the non-working spouse is considered not covered by a pension plan. If the employed spouse is covered by a pension plan, your deductible contribution decreases as your income level increases, and eventually is eliminated. This reduction starts when your income exceeds $183,000.
If your employer maintains a separate retirement savings account for each employee and you make voluntary contributions to that account, it is deemed a traditional IRA (or Roth IRA) as long as it meets the requirements of a traditional IRA.
Early Withdrawal Tax
Regardless of the type of IRA you contribute to, early withdrawal will cost you a 10% tax. An IRA withdrawal is considered early if you’ve had it for less than five years or you’re less than 59 ½ years old. However, there are exceptions to this additional tax. You may not be charged if:
You are totally, permanently disabled.
You are the legal beneficiary of a deceased IRA owner.
You use the IRA distributions (up to $10,000) to buy, build, or rebuild a qualified first home
You are unemployed and use the IRA funds to pay for health insurance premiums.
You have medical expenses that have not been reimbursed that exceed 10% of your adjusted gross income.
You use the IRA funds to pay for qualified higher education expenses.
Understanding your IRA and tax return can seem complicated, so contact Quality Tax Service for expert help on these issues.