Traditional Individual Retirement Account (IRA)
A Traditional Individual
Retirement Account (IRA) is a tax-advantaged arrangement that allows earnings
and deductible contributions to grow tax-deferred. It differs from a Roth IRA in a number
of important respects. In contrast
to a Roth IRA, you don't pay federal (and usually state) income taxes on the
earnings and deductible contributions of your IRA until you begin taking
withdrawals, usually after you retire and possibly are in a lower tax
bracket. Here's more information
about Traditional IRAs:
Tax advantages
Contributions may be deductible
from your gross income on your federal income tax return for the year in which
the contributions are made.
Earnings grow on a tax-deferred basis. Deductible contributions and earnings
are subject to federal income tax when withdrawn. If you live in a lower-tax state when
you withdraw contributions, you also save money on state income
taxes.
Eligibility requirements
You must
not attain the age of 70½ during the year you contribute to a Traditional
IRA. You must also have earned
income (compensation) in order to contribute to a Traditional
IRA.
Annual
contribution limits
In tax year 2005, you can make annual
contributions to a Traditional IRA of up to $4,000 or 100% of your earned
income, whichever is less. An
aggregate of $8,000 can generally be contributed per married couple ($4,000 per
IRA) provided that either you or your spouse has earned income of at least that
amount. The $4,000 and $8,000
annual contribution limits apply to the combination of all of your Traditional
and Roth IRAs.
If you are age 50 or older, you may make additional
"catch-up" contributions to your IRA.
Over the next several years, the maximum annual contribution amount will
increase as shown in the table below.
Note: Additional "catch-up"
contributions have been included in amounts shown for age 50 or
older.
|
Tax
year |
Under age
50 |
Age 50 or
older |
|
2005 |
$4,000 |
$4,500 |
|
2006-2007 |
$4,000 |
$5,000 |
|
2008 |
$5,000 |
$6,000 |
|
2009-2010 |
$5,000
indexed |
$5,000 indexed
plus $1,000 |
Distribution guidelines
You may take
distributions from a Traditional IRA starting at age 59½ -- distributions taken
before then are subject to taxes and tax penalties, unless taken for a qualified
exception. You may take
distributions in specific amounts, as a lump sum, or as a series of systematic
payments. Distributions are taxed
at ordinary income tax rates for the year the distribution was made. You are required to start taking
distributions from your IRA by April 1 of the year following the year in which
you reach age 70½.
The amount of your annual
contribution to a Traditional IRA that can be deducted from your federal income
taxes is dependent on two factors.
These factors are whether or not you or your spouse participates in an
employer sponsored retirement plan and the amount of your adjusted gross income
as determined on your federal income tax return. The following scenarios should help you
determine whether or not your contributions are deductible:
|
|
|
Adjusted gross
income | |||
|
Your
tax |
Tax
year |
Full
deduction |
Partial
deduction |
No
deduction |
|
Single/Head of
Household |
2005
on |
Up to
$50,000 |
$50,000 -
$60,000 |
Above
$60,000 |
|
Married Filing
Jointly |
2005 |
Up to $70,000
|
$70,000 -
$80,000 |
Above
$80,000 |
|
|
2006 |
Up to
$75,000 |
$75,000 -
$85,000 |
Above
$85,000 |
|
|
2007
on |
Up to
$80,000 |
$80,000 -
$100,000 |
Above
$100,000 |
|
Married Filing
Separately |
2001
on |
N/A |
$0 -
$10,000 |
Above
$10,000 |
|
|
Combined adjusted
gross income | ||
|
Tax
year |
Full
deduction |
Partial
deduction |
No
deduction |
|
2001
on |
Below
$150,000 |
$150,000 -
$160,000 |
$160,000 and
Above |
Some
examples wealth accumulation for Traditional IRAs, Roth IRAs, and taxable
accounts
The key
difference between Roth IRAs and Traditional IRAs is the federal and state
marginal tax rates when you are working versus when you are retired. Both investments compound at the
before-tax rate of return. The
following table illustrates the differences for a one-time $4,000 contribution
in 2005.
|
|
Example of
one-time contribution of $4000 to Traditional or Roth
IRA | ||
|
Assumptions |
|
Traditional IRA |
Roth IRA |
|
● Rate of return
= 8% ● Tax rate = 31%
during working life ● Tax rate = 15%
during retirement ● Hold for 30
years |
$34,213 |
$27,772 | |
|
● Rate of return
= 8% ● Tax rate = 15%
during working life ● Tax rate = 31%
during retirement ● Hold for 30
years |
$27,772 |
$34,213 | |
|
● Rate of return
= 8% ● Tax rate = 31%
during working life ● Tax rate = 31%
during retirement ● Hold for 30
years |
$27,772 |
$27,772 | |
|
● Rate of return
= 9% ● Tax rate = 31%
during working life ● Tax rate = 15%
during retirement ● Hold for 30
years |
$45,110 |
$36,618 | |
|
● Rate of return
= 9% ● Tax rate = 31%
during working life ● Tax rate = 15%
during retirement ● Hold for 40
years |
$106,792 |
$86,690 | |