Some things to consider about a Traditional IRA:
What is a Traditional IRA?
A Traditional IRA is a long-term tax advantaged savings plan. It is designed to leave more after-tax dollars for your retirement. You save money now, but the earnings are not taxed until you begin withdrawing the money in retirement, when you'll likely be in a lower tax bracket.
Who is eligible for a Traditional IRA?
Any income-earning individual can contribute to a Traditional IRA plan as long as they will not reach 70 ½ years of age by the end of the year in which they contribute.
Are there annual contribution limits on a Traditional IRA?
Contribution limits depend on your age: Those under age 50 can contribute up to $6,000 per year. For those older than 50, the contribution limit is $7,000, to allow for "catch-up" contributions.
Does contributing to an employer-sponsored retirement plan affect eligibility for a Traditional IRA?
No, your participation in an employer-sponsored retirement plan will not affect your ability to contribute to a Traditional IRA. Individuals in higher-income brackets will no longer be able to deduct their Traditional IRA contributions, however.
How much of my IRA contribution is tax-deductible?
Tax deductions are dependent on a combination of things, such as income, marital status and participation in an employer retirement plan. If you are single and not actively participating in a qualified retirement plan, your Traditional IRA contribution is deductible regardless of your income level. If you or your spouse is actively participating in a qualified retirement plan, your deduction limits will be income based. If your income is within the phase-out range, which is determined by your filing status, smaller deductions are available. For higher-income earners, deductions are not available if income is over the phase-out range, although they may still contribute. Everyone's tax situation is different, so BankFive recommends consulting a qualified tax advisor to determine how these rules apply to you.
When can I begin withdrawing from my Traditional IRA? Is there an age at which I am required to begin withdrawal?
Typically, you can begin withdrawing from your Traditional IRA after age 59 ½, and you will be required to begin receiving minimum distributions from your Traditional IRA at age 70 ½. Minimum distributions are computed using an IRS formula, and you are allowed to delay the first year's payment until April 1 of the following year. If you choose to do so, you will receive two years' worth of payments in that year.
Is there a penalty for early withdrawal from my Traditional IRA?
In most cases, there is a 10% tax on any withdrawals you make before the age of 59 ½. There are, however, some instances where withdrawing your funds early will not result in a tax penalty.
Penalty-free instances include:
How does a Traditional IRA differ from a Roth IRA?
- Withdrawing a contribution before the early withdrawal deadline
- Withdrawing an excess contribution after the filing deadline (conditions apply)
- Using the amount to pay for qualified post-secondary education expenses, medical expenses in excess of 7.5% of your Adjusted Gross Income (AGI), or to pay a federal tax levy
- Withdrawing up to $10,000 for a first-time home purchase in situations where the funds are being distributed to someone who is disabled (as defined by the IRS code)
- Using the amount to pay for medical insurance premiums during unemployment that lasts 12 weeks or longer
- Payments made to your beneficiaries after your death
- Moving the amount to a qualified plan (another Traditional IRA, or Roth IRA), provided transfer/conversion is processed according to Federal law regulations
Contributions made to a Traditional IRA are tax deductible on both state and federal tax returns for the year in which the contribution is made. When money is withdrawn from a Traditional IRA in retirement, that money is taxed according to your income tax rate. A Roth IRA on the other hand, is funded with “after tax” dollars. In other words, you’ve already paid taxes on the money before you place it in the Roth IRA. The trade-off is that the money in your IRA grows tax-free. There are no tax payments to be made when you withdraw the money. Furthermore, you can withdraw your contributions from a Roth IRA at any time without penalty, but you will be penalized for withdrawing any investment earnings before age 59 ½. There are income limits for Roth IRAs as well, so if you make upwards of $118,000 annually you could have your contribution limit reduced, or you could be ineligible for contributions altogether depending on your tax filing status and exact income level.
Can I move money from a Traditional IRA to a Roth IRA?
Yes, anyone with a Traditional IRA can convert it to a Roth IRA. You will have to pay federal income taxes on the amount that you moved, except the portion that is treated as the return from your Traditional IRA. In certain states, you may also be subject to state income taxes. Each person's financial situation is different, so it is best to contact your financial professional regarding your individual circumstances.
If I currently save in a traditional qualified retirement plan, can I transfer those funds into a Traditional IRA?
As long as you are permitted to receive an eligible rollover distribution from an employer's plan, you are able to transfer your funds to a Traditional IRA. It is recommended that you inform the plan administrator that you would like to move the funds to your Traditional IRA in a direct rollover; the plan administrator will inform you before making an eligible rollover distribution.
Will I pay income tax when I withdraw from my Traditional IRA?
Yes, withdrawal from your Traditional IRA results in the payment of income taxes. You can decrease your tax liability by making nondeductible contributions to a Traditional IRA or rolling over nondeductible contributions to a qualified retirement plan. A fraction of each distribution will be treated as a nontaxable return of these contributions.
What happens to my Traditional IRA after my death?
One or more beneficiaries should be designated to receive your IRA after your death. All beneficiaries have the option of receiving the funds over a period of time, or taking a lump-sum payment. Any tax-deferred money in your Traditional IRA at the time of death will be taxed when it is distributed to your beneficiaries. If your spouse is the designated beneficiary, he/she may directly transfer your Traditional IRA to his or her own Traditional IRA without paying a tax penalty.
This page is for informational purposes only and is not intended as tax advice. BankFive strongly recommends you consult a tax professional regarding your own financial situation.