t’s getting close to that time of year again; yes, it’s tax time! Time for Americans to gather their W-2s, tally their investment earnings or losses, sort through receipts and generally compile their documents in preparation for filing their taxes.
But it’s not all grim, even if you don’t get a refund. Each year you may have an opportunity to put savings aside for retirement on a tax-favored basis. I’m speaking, of course, of traditional IRAs as well as Roth IRAs. Many people do not understand the difference between these two. So what follows is an “IRA 101” on the two types of IRAs, and the relative pros and cons of each. I’ll be talking about 2012 limits since most people are making contributions now for the last calendar year.
This information is for general use and should not be relied on for your personal situation; please contact your financial adviser or tax consultant if you have additional questions.
Traditional IRA
• Contributions are tax-deferred
• Maximum 2012 contributions: $5,000 for tax year 2012; $6,000 if you are age 50+
• If you are not covered by an employer-sponsored retirement plan, contributions are fully deductible regardless of income OR
• If you are covered by an employer-sponsored retirement plan, your deductible amount depends on your income
• Upon withdrawal, you pay ordinary income tax on earnings and contributions
• Penalty for early withdrawal: 10% excise tax on withdrawals before age 59 ½ (certain exceptions apply)
• Required minimum distributions: age 70 ½
Roth IRA
• Roth contributions are made with after tax dollars
• Maximum 2012 contributions: $5,000 for tax year 2012; $6,000 if you are age 50+; BUT maximums are determined based on your income
• Contributions to a ROTH IRA are nondeductible; you pay full tax on these wages before making a contribution to a Roth
• Upon withdrawal: Distributions from contributions are tax free (since you have already paid tax on these monies before contributing).
• Distributions from earnings are generally federal tax free if you’ve had your Roth IRA for at least five years
• Penalty for early withdrawal: Distributions from contributions always tax-free; distributions from earnings are federal income tax-free if you’re over age 59 ½ or if you’ve had your Roth account for more than five years
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