Individual retirement arrangements, also referred to as IRAs, are tax favored personal savings arrangement’s that allow you to save money for retirement. There are several versions of IRAs that can be set up with a bank, insurance company, or another type of financial institution.
The original IRA is called a “traditional IRA”. When you go with this type of individual retirement arrangement, you will find that some of the contributions are deductible, if not all of them. Additionally, you may even be able to receive a tax credit that amounts to a percentage of your contribution.
Usually, you do not have to pay taxes on your traditional IRA until the money is distributed to you. However, they cannot be owned jointly. In the event that you were to die, your IRA would go to your beneficiary or beneficiaries.
You must be younger than 70 ½ to contribute
To contribute to a traditional individual retirement arrangement you have to be younger than 70 ½ when the end of the tax year comes around. In order to do so you and/or your spouse have to have taxable compensation. Taxable alimony and separate maintenance payments that you received are also referred to as compensation when regarding IRAs.
Compensation that is not included is your profits from properties, interest and dividend income, or any money that was deferred compensation, pension, or annuity income.
To figure out your eligible deduction use Form 1040, Form 1040A, or Publication 590. Form 1040 EZ does not allow you to claim IRA deductions so it is important that you use Form 1040 A or Form 1040. If you did not make any deductible contributions, you will have to use Form 8606.
To determine if you are eligible for a tax credit you will need to use Form 8880. If you are eligible for a tax credit, be sure to enter it on Form 1040 or Form 1040A. You will not be eligible to claim the credit if you use Form 1040 EZ.
You may be taxed
When the traditional IRA is distributed full or partial taxes will be due on them. If you made only deductible contributions, you can expect to be taxed fully. Form 8606 can assist you with determining the taxable portion of the withdrawn amount.
If you make distributions before you are 59 ½ you may have to pay 10% in additional taxes. You may also have to pay excise tax if you did not withdraw the minimum distribution before April 1 the year that you turn 70 ½. Additional taxes are determined and reported on Form 5329. However, there are a few exceptions for additional taxes.
Roth IRAs differ from traditional IRA in a few different aspects. Contributions are not deductible, which means you will not report your contributions when you file your taxes, and you are not taxed on qualified distributions or distributions that are a return of contributions. Furthermore, you do not have to be younger than 70 ½. However, the account or annuity has to be set up as a Roth IRA from the start.
IRS Publication 590 goes into more details about all of the other IRA types, and it includes information about conversions for each IRA type, contributions, and distributions.