Traditional Individual Retirement Accounts
With a Traditional IRA, you get a tax deduction for the savings you contribute to the account. This deduction reduces your taxable income, so you are basically not paying tax on the income you set aside in a Traditional IRA. The savings grow tax-deferred, which means you won't have to include interest, dividends, or capital gains from the IRA in your annual income. When you withdraw the money, the distribution from the IRA is included in your taxable income. It is taxed as ordinary income. If you withdraw the money before reaching age 59 and a half, there is an additional 10% tax on that early distribution. You must begin withdrawing money from a traditional IRA beginning with the year when you turn age 70.5 years old.There are restrictions on who can take a deduction for Traditional IRA contributions. If you or your spouse are covered by a retirement plan at work, your deduction may be limited or you might not be able to deduct any of your contribution.
Nondeductible Traditional Individual Retirement Accounts
A nondeductible IRA is a tax-deferred savings plan, just like the traditional IRA. However, the contributions are not tax-deductible. The savings grow tax-deferred. When you start taking distributions, part of the distribution will be a tax-free return of your original, nondeductible contribution, and the rest will be taxed as ordinary income. People usually opt for a nondeductible IRA when they are covered by a retirement plan through their employer but still want to contribute extra savings towards retirement. The only difference between a nondeductible IRA and a traditional IRA is the tax treatment of the original contribution.
Roth Individual Retirement Accounts
A Roth IRA provides potentially tax-free savings and distributions. Unlike a traditional IRA, you don't get a deduction for your contributions. The savings grow inside of the IRA without needing to pay any taxes on the earnings and growth. Distributions from a Roth IRA are completely tax-free, as long as you meet certain conditions. You can contribute to a Roth IRA even if you are covered by a retirement plan at work. But, Roth IRAs do have income limitations.
Simplified Employee Pension Individual Retirement Accounts
SEP IRAs are a type of group retirement plan. An employer establishes a SEP IRA plan, and then makes contributions to a traditional IRA set up inside of the SEP IRA plan. SEP IRAs are popular with self-employed people, because SEP IRAs allow for higher contribution limits than a regular IRA. Otherwise, SEP IRAs are treated similarly to traditional IRAs. Contributions are made with pre-tax dollars, distributions are taxed as ordinary income, and there are penalties for taking an early distribution.
Savings Incentive Match Plans for Employees
SIMPLE IRAs are also a group retirement plan. They are easier to set up and maintain than 401(k) or pension plans, but they offer lower contribution limits than other group plans. SIMPLE IRAs allow for pre-tax dollars to be contributed, with matching from the employer. Distributions are taxed as ordinary income, and there are penalties for early distributions.
IRA Contribution Limits
For Traditional, Nondeductible, and Roth IRAs, the most you can contribute in any year is $5,000. This is the maximum IRA contribution limit for the years 2008, 2009, 2010, and 2011. If you are age 50 or older, you can contribute up to $6,000 for the year. This is a single dollar limit for traditional, nondeductible, and Roth IRAs. So if you wanted to fund both a traditional IRA and a Roth IRA, you could put $2,500 in a traditional and another $2,500 in a Roth, for example. Your total contributions cannot exceed the annual maximum.IRA contributions are also limited by your qualifying income. For IRA purposes only, qualifying income means wages, self-employment income, alimony, and nontaxable combat pay. For example, let's say you have wages of $3,500 and no other income. Your can contribute up to $3,500 in any combination of traditional, nondeductible, or Roth IRA for the year.
