When it comes to saving for retirement, an Individual Retirement Account (IRA) is one of the best ways to ensure you have money set aside for later in life. An IRA is a common type of investment vehicle that is designed to help you prepare for retirement, while offering varying tax advantages.
While an IRA is a great way to prepare for the future, the rules and regulations differ based on many factors, such as the type of IRA account you set up (Traditional and ROTH), your age, filing status, income levels, and other retirement investment holdings.
With a Traditional IRA, the 2016 maximum contribution for someone younger than 50 is $5,500 while that amount raises to $6,500 per account for those 50 and older. Traditional IRAs are tax-deferred accounts, meaning you don’t pay taxes on the money contributed until you withdraw it during retirement. This money is then taxed as normal income based on your taxable income rate at the time of distribution, and you are required to start deducting from the account once you turn 70 ½ years old. Distributions are allowed for those between the ages of 59 ½ and 70 ½ without being subject to a penalty, however, these distributions are subject to federal and state income taxes.
While the ability to contribute to a traditional IRA is not restricted by income (you can contribute up to the previously mentioned annual limits), the ability to deduct the contributions on your tax return is restricted by income, and there is a phase-out of the tax deductibility of contributions based on your Adjusted Gross Income (AGI) AND whether or not you or your spouse is covered by an employer’s retirement plan.
Traditional IRA income limits for the tax deductibility of contributions are the following in 2016 if you ARE covered by an employer’s retirement plan:
- Single or Head of Household Individuals – all contributions are tax deductible for those with AGI
< $61,000, a phase-out (partial tax deductibility) is allowed for those with AGI from $61,000 – $71,000, and those with AGI > $71,000 are not allowed any tax deduction on their
- Married Filing Jointly – all contributions are tax deductible for those with AGI < $98,000, a phase- out (partial tax deductibility) is allowed for those with AGI from $98,000 – $118,000, and those with AGI > $118,000 are not allowed any tax deduction on their contributions.
- Married Filing Separately – Individual is not able to take advantage of the full tax deductibility
limit. Partial tax deductibility is allowed for an individual with AGI < $10,000, and individuals with AGI > $10,000 are not eligible to deduct their contributions on their income tax return.
Traditional IRA income limits for the tax deductibility of contributions are the following in 2016 if you ARE NOT covered by an employer’s retirement plan:
- Single or Head of Household Individuals – there are no income limit
- Married Filing Jointly – there is no income limit
- Married Filing Jointly (Your spouse has a retirement plan) – all contributions are tax deductible
for those with AGI < $184,000, a phase-out (partial tax deductibility) is allowed for those with AGI from $184,000 – $194,000, and those with AGI > $194,000 are not allowed any tax
deduction on their contributions.
- Married Filing Separately (if your spouse is covered at work) – Individual is not able to take advantage of the full tax deductibility limit. Partial tax deductibility is allowed for an individual with AGI < $10,000, and individuals with AGI > $10,000 are not eligible to deduct their contributions on their income tax return.
Unlike Traditional IRAs, for ROTH IRA’s an individual (or married couple) pays taxes on the contributions made rather when distributions are taken. Any gains and distributions on qualified distributions of ROTH IRA’s are tax free.
With a Roth IRA, the maximum contribution amounts are the same as with a Traditional IRA, however, your overall eligibility to contribute to this type of IRA depends on your income. You MUST have earned income of at least your contribution amount to be allowed to contribute to a ROTH IRA.
Roth IRA’s contribution limits are based on the following Modified Adjusted Gross Income (MAGI) levels:
- Single or Head of Household Individuals – full contribution amounts are allowed for those with
MAGI < $117,000, a phase-out (partial contribution) is allowed for those with MAGI from $117,000 – $132,000, and those with MAGI > $132,000 are not eligible to make contributions.
- Married Filing Jointly – full contribution amounts are allowed for couples with MAGI < $184,000, a phase-out (partial contribution) is allowed for couples with MAGI from $184,000 – $194,000, and couples with MAGI > $194,000 are not eligible to make contributions.
- Married Filing Separately – Individual is not able to take advantage of the full contribution limit. A partial contribution is allowed for an individual with MAGI < $10,000, and individuals with MAGI > $10,000 are not eligible to make contributions.
As previously stated, a qualified distribution from a ROTH IRA is tax and penalty free, provided that the individual has held the ROTH IRA for a minimum of 5 years, and one of the following conditions is met:
- The individual is over the age of 59 ½
- Death or disability
- Qualified first-time home purchase
A non-qualified distribution is subject to taxation of the gains on the original contributions, plus an additional 10% penalties unless exception rules apply. You can always remove post-tax contributions (known as “basis”) from your ROTH IRA without penalty. Unlike traditional IRA’s, there are no required withdrawals during the lifetime of the original owner.
A Spousal IRA is simply a regular IRA (Traditional or ROTH) setup for a non-working spouse, and allows each person to contribute to their retirement when there is only one person with earned income. Once this IRA is established, it belongs to that individual exclusively (even after a divorce), and that individual has sole authority over investing and withdrawal decisions.
A spousal IRA can be either a traditional or a Roth IRA, with the differences in tax treatment applying in the same manner that they would for someone who had earned income. The same income limits on deductibility of Traditional IRA contributions apply, and the same income-based restrictions on making Roth IRA contributions apply for a spousal IRA.
The eligibility requirements for the spousal IRA are as follows:
- The couple must be married with a filing status of Married Filing Jointly
- Contributing spouse must have earned income for the tax year of at least the amount contributed to both individual’s IRA’s for that tax year.
- The non-working spouse must be under 70 ½ at the end of the tax year of the contribution for a Traditional IRA. There are no age restrictions on contributions made to a ROTH IRA for a non-working spouse.
With any IRA account, you can make your contributions either during the tax year or by the filing dead-line for that year’s taxes (for 2016, this is April 17, 2017) to have the amount counted toward the tax year in which you are filing. IRA’s are a great way to boost household retirement savings, and to create a stable financial future for you and your loved ones. Do your research to find the type that is right for you, and start contributing today.
As you can see, there are many age, income, contribution, and distribution rules and limitations associated with both Traditional and ROTH IRA’s. For more information and assistance with tax planning for the present and future, visit Evolve Financial today.