In a January article dealing with the topic of minimum required distributions (MRDs) (See Taxes and Your 2009 TSP Distributions: How To Lower Your Taxes), I mentioned traditional deductible and non-deductible Individual Retirement Accounts (IRAs) a few times. This article differentiates between the different types of IRAs that are available and the requirements for investing in them. We will look at the three types of IRA in the order of their appearance on the retirement investing scene.
First on the scene (in the 1970s) was what is today referred to as a traditional deductible IRA. To contribute to a traditional deductible IRA, you must have earned income and be under the age of 70 ½. In a traditional deductible IRA:
- Contributions are from pre-tax dollars
- The money in the IRA grows tax deferred
- When the money is withdrawn, all of it is taxed as ordinary income
- There is a 10% early withdrawal penalty for any money you take out before the age of 59 ½
- There is a 50% penalty for failing to take a MRD each year once you reach the age of 70 ½
BUT WAIT! You cannot deduct IRA contributions (i.e., you cannot contribute to a traditional deductible IRA) if your income is over certain levels and you belong to a retirement plan through your employer (as all federal employees do).
If your filing status is single you can fully fund a traditional deductible IRA if your income is below $55,000; you may partially fund it if your income is between $55,000 and $65,000; you may not fund it at all if your income is over $65,000.
If your filing status is joint and your spouse also belongs to a retirement plan at work you can fully fund a traditional deductible IRA if your income is below $89,000; you may partially fund it if your income is between $89,000 and $109,000; you may not fund it at all if your income is over $109,000.
If your filing status is joint and your spouse does not belong to a retirement plan at work you can fully fund a traditional deductible IRA if your income is below $166,000; you may partially fund it if your income is between $166,000 and $176,000; you may not fund it at all if your income is over $176,000.
In 1986 the traditional non-deductible IRA appeared. To contribute to a traditional non-deductible IRA, you must have earned income and be under the age of 70 ½. In a traditional non-deductible IRA:
- Contributions are from after-tax dollars
- The money in the IRA grows tax deferred
- When the money is withdrawn, the earnings are taxed as ordinary income
- There is a 10% early withdrawal penalty for any money you take out before the age of 59 ½
- There is a 50% penalty for failing to take a MRD each year once you reach the age of 70 ½
There are no income limits on contributing to a traditional non-deductible IRA.
The mid-90s brought us the Roth IRA. It has several differences from the traditional IRAs that may be to your advantage if you meet the income restrictions. To contribute to a Roth IRA you must have earned income, but can be of any age. In a Roth IRA
- Contributions are from after-tax dollars
- The money in the IRA grows tax-free in most circumstances
- If when the money is withdrawn, the account has been open for at least five years and you are at least age 59 ½ the earnings are tax-free
- There is a 10% early withdrawal penalty for any earnings you take out before the age of 59 ½
- You are never required to take a MRD
BUT WAIT! There are income restrictions on contributing to a Roth IRA.
If your filing status is single you can fully fund a Roth IRA if your income is below $105,000; you may partially fund it if your income is between $105,000 and $120,000; you may not fund it if your income is over $120,000.
If your filing status is joint you can fully fund a Roth IRA if your income is below $166,000; you may partially fund it if your income is between $166,000 and $176,000; you may not fund it if your income is over $176,000.
You may convert a traditional IRA to a Roth IRA if your income is below $100,000 (either single or joint filing status). The $100,000 income limit expires in 2010.
Note: The income restrictions listed for traditional deductible and Roth IRAs are for 2009. The 2008 amounts are lower and can be found on the IRS website, or in IRS publication 590. You have until April 15, 2009 to contribute to a 2008 IRA.
