The only requirement to open and contribute to a traditional IRA is that you must have taxable compensation and be under age 70-and-a-half. So as we steam into the 2013 tax season let’s look at the history of the IRA and some guidelines that may help our clients better prepare for the future while managing their assets and income today.

What is an IRA?

Established by the Federal Government, an IRA is an Individual Retirement Account. It is a method to encourage retirement savings.

Timeline of IRAs

1974 Introduced with enactment of the Employee Retirement Income Security Act (ERISA).

  • Initial program restricted IRAs to workers not covered by a qualified employment-based retirement plan.
  • Maximum contribution was $1,500.

1981 Economic Recovery Tax Act allowed all taxpayers under the age of 70-and-a-half to contribute to an IRA, regardless of their coverage under a qualified plan.

  • Maximum annual contribution rose to $2,000.
  • Allowed participants to contribute $250 on behalf of a non-working spouse.

1986 The Tax Reform Act of 1986 reversed the trend toward expanded participation by phasing out the deduction for IRA contributions among higher-earning workers who are covered by an employment-based retirement plan themselves or who have a covered spouse.

1996 Small Business Job Protection Act 1996 raised the limit on contributions on behalf of non-working spouses from $250 to $2,000.

1997 Taxpayer Relief Act of 1997 created Roth IRAs. Purpose was to encourage retirement savings.

2001 Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) raised limits on contributions beginning in 2002 and allowed “catch-up” contributions by people ages 50 and above.

2006 Congress makes it easier for high-income taxpayers to contribute to Roth IRAs.

Types of IRAs

  • Traditional
  • Roth
  • Spousal
  • Rollover
  • SEP
  • SIMPLE

Traditional IRA

Contributions are often tax-deductible. All transactions and earnings within the IRA have no tax impact and withdrawals at retirement are taxed as income.

Roth IRA

Contributions are made with after-tax assets. All transactions within the IRA have no tax impact, and withdrawals are usually tax free.

SEP IRA

SEP – Simplified Employee Pension – is a provision that allows an employer to make retirement plan contributions into a Traditional IRA established in the employee’s name, instead of to a pension fund account in the company’s name.

SIMPLE IRA

SIMPLE IRA – Savings Incentive Match Plan for Employees IRA– is a simplified employee pension plan that allows both employer and employee contributions, similar to a 401(k) plan, but with lower contribution limits and simpler administration.

Traditional vs. Roth IRA

 

 

 

 

Spousal IRAs

For a spouse who does not participate in an employer-sponsored plan, contributions to a Traditional IRA are:

  • Fully deductible for married couples with modified adjusted gross income (MAGI) of $173,000 or less for tax year 2012 and $178,000 or less for tax year 2013.
  • Partially deductible for married couples with a MAGI of more than $173,000 and less than $183,000 for tax year 2012 and more than $178,000 and less than $188,000 for tax year 2013.

Married couples with a MAGI of $183,000 and above for tax year 2012 and $188,000 and above for tax year 2013 may still make, but not deduct, contributions to a Traditional IRA.

Spousal Contributions to Roth IRA

Contributions to a Roth IRA are never tax-deductible; however, contributions and any earnings can potentially grow tax-free for retirement. In order to contribute to a Roth IRA for yourself or your spouse, married couples must have a MAGI of less than $183,000 for tax year 2012 and less than $188,000 for tax year 2013.

In general, if you plan to stay invested for five years or more, you don’t expect your taxable income to significantly decrease in retirement, and you don’t plan to withdraw the assets before age 59-and-a-half, a Roth IRA may be the better choice for long-term retirement savings.

Rollover IRAs

This IRA is set up by an individual to receive a distribution from a qualified retirement plan. There is a 60-day window to withdraw from one plan and rollover into another IRA without incurring a penalty.

 

 

Advantages

Traditional (tax-deductible)

  • Save for your retirement
  • Contributions are tax deferred
  • May help reduce your taxes
  • Investment income is not taxed until it is withdrawn

Advantages

Roth

  • Contributions can be made after age 70-and-a-half, if you receive earned income.
  • Contribution eligibility is not restricted by active participation in an employer’s retirement plan.

Withdrawals of earnings are tax-free in the case of:

  • Death
  • Disability
  • First-time home-buying
  • After age 59-and-a-half

Comparison – taxes due after 70-and-a-half

Tax-Deductible IRA

Income tax due on earnings and original contributions.

Nondeductible IRA

Income tax due on earnings (original contributions are withdrawn tax-free).

Roth

  • No tax due if funds are held in the account for at least five years.
  • Total amount of annual contributions can be withdrawn tax-free and penalty-free at any time.

Taxes Due After 59-and-a-half

Tax-Deductible IRAs

Income tax due on earnings and original contributions.

Nondeductible IRAs

Income tax due on earnings (original contributions are withdrawn tax-free).

Roth IRAs

  • No tax due if funds are held in the account for at least five years.
  • Total amount of annual contributions can be withdrawn tax-free and penalty free at any time.

Early withdrawals

 

Additional Roth

 

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