There are many types of IRAs. This article will discuss Traditional IRAs, Roth IRAs and non-deductible IRAs, available to individuals (or a spouse of an individual) with earned income or collecting alimony.
The first criterion to consider is your age. If you are over 70 ½ at the end of the tax year, the only IRA to which you can contribute is a Roth IRA.
If you or your spouse is covered by an employer retirement plan, there are limits to the amount that can be contributed to a traditional (deductible) IRA. If you are the covered employee, your ability to contribute to a traditional IRA begins to phase out for 2016 at $98,000 of modified adjusted gross income (AGI) and is completely phased out at $118,000 if married filing jointly. Filing separately won’t help unless your AGI is less than $10,000. However, the phase out range is $61,000-$71,000 if you’re filing single or head of household. If your spouse is covered by a retirement plan it will affect your ability to fund a retirement plan beginning at AGI of $184,000 with a complete phase out at $194,000. Filing separately again is not a viable strategy since the ability to make a contribution phases out completely at $10,000.
There are no restrictions on contributing to a Roth or Nondeductible IRA based on participation in an employer retirement plan. However, there are income restrictions on funding a Roth IRA. If modified AGI is over $10,000 when married filing separately, no contribution is allowed. However, the phase out is less onerous if filing jointly ($184,000-$194,000) or single or head of household ($117,000-$132,000).
Does it make a difference what kind of IRA you choose? Absolutely. The Traditional IRA is a current year tax deduction. Neither the Roth nor Nondeductible IRA provides a current tax benefit. For those accounts, the tax benefit comes when the funds are withdrawn. Qualified distributions from a Roth IRA are never taxable. Generally, distributions from a Traditional IRA are all taxable for federal purposes. Nondeductible IRAs contain previously taxed funds (your contributions) and untaxed funds (the income and gains on the contributions). You are not taxed on the return of your contributions but you are taxed on the income generated. That requires tracking the contributions to and withdrawals from the account to avoid double taxation.
If you decide you’re ready to fund an IRA you can contribute for 2016 up to $5,500 with an additional $1,000 allowed for people 50 and older. That amount can be split among the different types of IRAs but the total of all contributions cannot exceed the limit. Contributions must be made by the original due date for filing your return and may not exceed total earned income (or alimony). If a joint return is filed, the total of the IRA contributions for the parties may not exceed their combined earned incomes.
Age 59 ½ is generally when you can take a Traditional IRA distribution without penalty. There are a number of exceptions to the imposition of a 10% penalty on early distribution, but if you anticipate needing your investment in the IRA before age 59 1/2, you should carefully consider whether the Traditional IRA is the retirement vehicle for you.
Traditional, Roth, and Nondeductible IRAs are an ideal way to save for retirement. The type of account you can choose depends on your needs, your income, and whether you or your spouse is a participant in an employer plan. For more information on these accounts and other instruments for retirement savings, please contact us.
