Individual retirement account owners may invest in the same financial instruments for both traditional and Roth IRAs. The difference in earnings on these investments is the eventual tax consequences. Earnings on traditional IRAs are tax-deferred, while earnings on Roth IRAs are tax-free upon withdrawal. However, eligible taxpayers may deduct traditional IRA contributions from federal tax returns. Roth IRAs are not deductible.
As of publication, the annual maximum contribution amount for both traditional and Roth IRAs is $5,000 for taxpayers under the age of 50 and $6,000 for those age 50 and over. The minimum age for taking distributions from a traditional IRA is 59 1/2, and the Internal Revenue Service requires mandatory distributions once the account owner reaches the age of 70 1/2. Traditional IRA distributions are taxed as ordinary income, but most retirees find themselves in a lower tax bracket than during their employment years.
Roth IRA contributions are made with after-tax earnings. While the contributions are non-deductible, once the account owner reaches the age of 59 1/2, as long the Roth IRA has been open a minimum of five years, withdrawals of earnings are tax-free (withdrawals of contributions are always tax-free). Unlike the traditional IRA, there is no mandatory age for withdrawal and contributions may continue to be made to Roth IRAs when the account owner is past the age of 70 1/2 as long as she has earned income. Contributors to Roth IRAs must meet adjusted gross income (AGI) limits. As of publications, single filers with an AGI under $107,000 may make a full contribution, while those earning between $107,000 and $122,000 can make a partial contribution. Married couples filing jointly have an AGI limit of $169,000 to make full contributions, with an AGI between $169,000 and $179,000 for partial contributions.
Traditional IRA Deductibility
Anyone may contribute to a traditional IRA if they have earned income, but not everyone qualifies for the deduction. Traditional IRA account owners who do not have an employer-sponsored retirement plan may deduct contributions no matter what their adjusted gross income. If they are covered by an employer-sponsored retirement plan, such as a 401k, single filers with an AGI of $56,000 or less may take a full deduction on the contributions, and a partial deduction is available for those with an AGI of up to $66,000. Married couples filing jointly with both spouses covered by a employer-sponsored retirement plan may take a full deduction if their AGI is $90,000 or less. Up to $110,000, a partial deduction is available.
Early Withdrawal Penalties
The IRS levies ordinary income taxes as well as an additional 10 percent penalty on any amount withdrawn from a traditional IRA or any earnings from a Roth IRA if the account owner is under 59 1/2. In some cases, the additional penalty is not imposed but the amount withdrawn is still taxed. The exceptions for the penalty include funds used to pay medical expenses over 7.5 percent of the account owner's AGI; purchase of a first home; higher education costs for the account owner, spouse or child; or if the account owner becomes totally and completely disabled.
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