Individual Retirement Savings Options

Contrary to popular belief, an IRA, or Individual Retirement Account, is not an investment product like a stock, bond or mutual fund. It’s merely an account in which investments are held for the purpose of retirement savings.

axstj-savingsdsc_1676-stj-1013-5575-web.jpgThere are several types of IRAs: Traditional, Roth, SIMPLE and SEP. The Traditional and Roth are available to individuals while the SIMPLE and SEP are employer sponsored plans. This article will focus on just Traditional and Roth accounts.

While there may be several reasons why you’d want to invest money in an IRA, the primary reason is for the tax advantages offered by the federal government. Here are some specifics:

Traditional IRA

Although subject to change annually, in 2010 an individual may be eligible to invest up to $5,000 of pretax earnings in a Traditional IRA. For those over the age of 50, you can do an additional “catch-up” contribution of $1,000.

The primary advantage is that you may be able to deduct the contributions which reduces the amount of income subject to federal taxes. The account grows tax deferred until withdrawals are made, at which time they’re taxed as ordinary income. The common assumption made is that most people will have lower income levels in retirement and therefore be taxed at a lower rate. Although a fair assumption in most cases, this may not always the case. And, there’s no guarantee that tax rates themselves won’t be higher in the future.

Rules & Restrictions: Here are some specifics on a Traditional IRA:

  1. Withdrawals prior to age 59 ½ are taxed as ordinary income as well as subject to a 10% penalty unless certain exceptions are met (death, or disability for example).
  2. At age 70 ½ you’re required to take mandatory distributions (Required Minimum Distribution) or a 50% penalty equal to the amount that should have been taken is assessed.
  3. Contributions are limited to $5,000 ($6,000 if over 50 years old) or 100% of your taxable compensation, whichever is less.
  4. Tax deduction – depending on your modified adjusted gross income, and if you are or aren’t covered by a retirement plan at work will affect if you can deduct your full contribution. Review this years IRS table for more details.
Roth IRA

Contribution limits are the same but are not tax deductible. The account does, however, grow tax free and distributions are taken tax free after age 59 1/2. You can also withdraw all contributions once any Roth account has been established for at least 5 years.

Rules & Restrictions: Here are some specifics on a Roth IRA:
  1. Free to withdraw any direct contributions tax free at any time after the seasoning period (5 years).
  2. There are no required minimum distributions at age 70 ½.
  3. There are contribution limits to a Roth IRA based on income.
  • Single or head of household filer- full contribution ability with income up to $105,000. Partial contribution with income $150,000-$120,000. No contribution if income over $120,000.
  • Joint filer- full contribution with income up to $166,000. Partial contributions between $166,000-$176,000. No contribution if over $176,000.

To summarize, the advantage of investing in an IRA is the tax savings. The difference between a Traditional IRA and Roth IRA is when you receive the tax benefit. With the Traditional IRA you receive the tax benefits immediately and with a Roth you receive it in retirement.

Because everyone’s situation is different, and predicting your future tax bracket isn’t a black and white calculation, I recommend you consult with a tax or financial professional to determine what options are best for you.