individuals may invest in traditional Individual Retirement Accounts and deduct the contributions on the federal income tax return, if they meet certain criteria. Since traditional IRAs contributions are made with pretax dollars, amounts withdrawn in retirement are subject to tax at the owner's income tax rate. Presumably, that tax rate is lower than the rate before retirement.
Traditional IRA Contributions
You may contribute up to $5,000 annually in a traditional IRA , assuming that amount is earned in compensation. Those between age 50 and 70 1/2 may contribute up to $6,000 in what is known as a catch-up contribution. Annual contributions may be made to more than one traditional IRA account, but the total amount contributed cannot exceed the limit. Contributions to traditional IRA accounts are tax-deferred. These contribution limits reflect 2011 tax laws, and are subject to change year to year.
Deducting the IRA
While all taxpayers may open and contribute to traditional IRAs, not everyone may deduct the contributions on the federal tax return. No matter what your income is, if you are not covered by an employer-sponsored retirement plan such as a 401k, traditional IRA contributions are deductible. For 2011, those covered by an employer-sponsored retirement plan may take the deduction if meeting income restrictions. Single taxpayers with an adjusted gross income (AGI) of $56,000 or less may take a full deduction on the IRA contributions, and may take a partial deduction with an AGI of up to $66,000. Over that amount, no deduction is allowed. Married taxpayers filing jointly with both spouses covered by a retirement plan may take the full deduction if the AGI is $90,000. Up to $110,000 they may take a partial deduction, but no deduction is permitted if the AGI is above that amount.
Traditional IRA owners may start taking distributions upon reaching the age of 59 1/2, and mandatory withdrawals must start by age 70 1/2. Those making withdrawals before the minimum age face taxes on the amounts withdrawn as ordinary income, along with a 10 percent penalty levied by the Internal Revenue Service. However, the IRS allows withdrawals in certain circumstances to avoid the additional penalty, although not the ordinary income tax.
Exceptions for Penalties
Traditional IRA owners may make early withdrawals and avoid the 10 percent additional penalty if the money is used to buy or build a first home, pay for the higher education expenses of the owner, spouse or child; or pay medical expenses exceeding 7.5 percent of the annual AGI. IRA owners who become legally disabled may also make withdrawals without paying the penalty.
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