Navigating the calculations involved in an individual retirement arrangement (IRA) can resemble the planning for a moon landing. Even tax experts usually have to consult a manual to assure following Internal Revenue Service rules. Almost anyone can contribute to a traditional IRA but not necessarily a Roth IRA. There are maximum contribution limits and calculations to determine if amounts are tax-deductible. IRA distributions involve calculating required minimums and penalties for withdrawing too much.
Contributions to a traditional IRA are often tax-deductible but can be eliminated or reduced for anyone covered by a retirement plan at work and also having income above specified limits. The income thresholds are based upon filing status and a calculation of "modified adjusted gross income," which is the same as the adjusted gross income line on a tax return for most people. These amounts are adjusted for annual inflation. Tables 1-2 and 1-3 in IRS Publication 590 list the income limits for making tax-deductible IRA contributions.
As of publication, the maximum annual IRA contribution is $5,000. But, individuals who are age 50 or older may contribute $6,000. However, contributions require taxable compensation. Therefore, IRA contributions cannot exceed total compensation from wages or self-employment. Taxable compensation does not include income from investments, rental activity or pensions. The IRA limit applies to total contributions per year for all IRAs.
Someone with no income from working can "borrow" from the compensation of a spouse to make an IRA contribution. This is calculated by reducing the compensation of the working spouse by any IRA contributions of that spouse. The difference is available for the non-working spouse to make an IRA contribution -- up to the maximum of $5,000 or $6,000 if the non-working spouse if age 50 or older.
The owner of a traditional IRA is required to take distributions based upon a calculation using IRS life expectancy tables. Required minimum distributions begin at age 70 1/2. Distributions from a traditional IRA are taxed unless they represent in whole or in part some return of previous contributions that were not tax-deductible. Any distribution before age 59 1/2 also incurs a 10-percent penalty tax unless an exception applies.
Roth IRA Contributions
Contributions to a Roth IRA are not tax-deductible. However, a calculation is required to determine if an individual is eligible for this type of IRA. Eligibility for a Roth IRA requires modified adjusted gross income that's lower than thresholds established for different types of filing statuses. These amounts are adjusted for cost of living. Table 2-1 in IRS Publication 590 lists the income limits for individuals making Roth IRA contributions. The maximum annual IRA contribution of $5,000 -- or $6,000 for someone age 50 or older -- is a combined limit for both traditional and Roth IRAs.
Roth IRA Distributions
There are no required minimum distributions from a Roth IRA at age 70 1/2. Distribution of any previously contributed amount is never taxable. Also not taxed are distributions five years after opening the account as long as the account owner is at least age 59 1/2, disabled or using up to $10,000 for a first-time home purchase. A distribution not meeting one of these qualifications also incurs a 10-percent penalty unless an exception applies.
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