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IRAs: Traditional and Roth
If you’re looking for ways to save for retirement on your own, or if you’d like to add to the benefits of your employer’s plan, individual retirement plans, or IRAs, are the best place to start.
IRA’s were established by Congress as a way to help individuals save for retirement on their own. Until a few years ago, there was just one type of IRA. Today, there are two: the traditional IRA and the Roth. Each one functions a little differently and includes different benefits, so read on…and find out which one might better fit your situation.
Traditional IRA
You’re probably not surprised to learn that anything enacted by Congress has a number of rules to go along with it.
In a nutshell, this is how the traditional IRA works. The traditional IRA lets you put a certain amount of money into the account each year. Some or all of the money you put into that account may be deductible on your income taxes for that year. As long as your money is in the account, it accumulates income tax deferred, and then when you want to take your money out at retirement, you pay taxes on it at that time.
That’s the nutshell…now let’s talk about the nut.
Who’s allowed to open a traditional IRA?
- You have to be under age 70 ½ and have received compensation from employment.
- If your employer provides a retirement plan for your benefit, whether or not you participate in that plan, you may contribute up to $4000* to your IRA.
- Not all of that $4,000 contribution may be tax-deductible. If your employer does NOT have a pension plan, you can deduct the full $4,000. If your employer does provide a pension plan, the amount of your IRA contribution that is income tax deductible is phased out if your income is between $50,000 to $60,000 for individuals and $70,000 to $80,000 for people filing jointly. Incomes above those amounts may make the contribution to the IRA, but they may not be deducted from your income taxes.
- If you’re married, both you and your spouse can contribute to an IRA. Even if your spouse doesn’t work, he or she can open a “spousal” IRA with a $250 limit.
- You can invest your IRA dollars in a wide range of investments, and the earnings on your IRA grow income tax-deferred.
- You should not plan on spending your IRA money until you retire. If you withdraw money before 59 ½, you have to pay regular income taxes on your withdrawal and you are subject to an additional 10% penalty tax. There are some exceptions to this rule and your financial professional can tell you more.
When it’s time to spend the cash
- After 59 ½ you can take your money out of your IRA at any time, however, you will have to pay income taxes when you make your withdrawals.
- You can leave your IRA alone until you reach age 70 1/2 , which is when the IRS will require that you take a minimum amount out each year. (This is so you don’t use your IRA as a permanent tax shelter until you die.) The minimum amount that you must withdraw is based on your life expectancy. It is known as your “Required Minimum Distribution.”
Roth IRA
The most notable difference between a traditional and Roth IRA is that none of your contributions to the Roth IRA are income tax deductible, however, when you make withdrawals from your Roth IRA at retirement…you don’t have to pay any income taxes.
Unfortunately, not everyone is allowed to open a Roth IRA. Your adjusted gross income (AGI) must be less than $95,000. Your Roth IRA contribution amount is phased out between $95,000 and $110,000. (limits are higher if you’re married)
Best of all, Roth IRA investments grow completely income tax free after the account has been open for five years.
When it’s time to spend the money
- The same early withdrawal penalties apply if you’re under 59 ½.
- The contributions have to be in the IRA for five years in order for the withdrawals to be tax-free.
- You don’t have to make mandatory withdrawals at 70 ½. You can let the money accumulate for as long as you like.
How to Open an IRA
An ING financial professional can help you with opening the IRA that’s right for you and help you select investments appropriate for your situation.
*If you’re over 50, you may contribute an additional $500 as a catch-up contribution to your IRA. Congress added this catch-up contribution to allow older workers to save more for their retirement.
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