The U.S. Congress authorized individual retirement accounts as a means for individuals to increase retirement savings. Initially, these plans were restricted to those not covered by an employer plan, but that was eventually changed, with some restrictions. Currently there are two types of IRA available: traditional IRAs and Roth IRAs. Both offer significant tax incentives, but only one allows you to deduct your contributions when you file your federal income tax return.
You can deduct contributions to your traditional IRA from your income when you file your federal income tax return. This deduction is taken as an adjustment to your income and may be taken whether you itemize your deductions or claim the standard deduction. Your contributions to your traditional IRA will result in a lower adjusted gross income, commonly referred to as AGI.
Generally, an individual can contribute -- and deduct -- up to $5000 annually to a traditional IRA, as long as that amount does not exceed his income. IRA owners age 50 and older can deduct another $1000, and as long as one spouse is working, a non-earning spouse can also make deductible contributions up to allowable limits. The deductibility of traditional IRA contributions is limited, based on income, for those who are covered by a plan at work or whose spouse is covered. For example, in 2011, if you are covered by a plan at work and are married filing jointly, your deduction would begin to phase out if your AGI was more than $89,000 and would disappear if your AGI was $109,000 or more. If only your spouse is covered by an employer plan, the phase-out is for AGIs between $167,000 and $177,000.
Contributions to your Roth IRA are not deductible from your income when you file your federal income tax return. However, in both a traditional and a Roth IRA, investment earnings within the plan are not taxed. Investments outside the plan are included in gross income.
For Roth and traditional IRAs, qualified withdrawals are defined as withdrawals after age 59 1/2. In both cases withdrawals before that age not attributable to after-tax contributions are taxed as ordinary income and also subject to a 10 percent penalty tax. Traditional IRA contributions after age 59 1/2 are still taxed as income, but no penalty applies. Qualified distributions from a Roth are tax free.
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