Individual Retirement Account
An Individual Retirement Account (IRA) is a tax shelter for retirement savings. Tax shelters are methods of reducing one’s tax burden. An IRA is a particular kind of tax shelter that focuses on retirement savings.
As summarized below, the two main IRA account types are Traditional and Roth IRAs. In general, Traditional IRAs provide tax deductions and tax-deferred growth, whilst Roth IRAs offer tax-free growth and tax-free distributions.
TRADITIONAL IRA
Taxes &/or Penalties on Contributions
<70 1/2: See Deductions & Contribution Limits
>70 1/2: 6% excess contribution penalty on entire contribution
Taxes &/or Penalties on Distributions
>59 1/2: Taxed as ordinary income
<59 1/2: 10% on withdrawal + aforementioned
>70½: 50% of what should have been withdrawn (RMD)
ROTH IRA
Taxes &/or Penalties on Contributions
Non-deductible/after-tax (i.e. No 70 1/2 age limit)
Taxes &/or Penalties on Distributions
>59½ & >=5 yrs: Tax-free (Sounds too good to be true? Well, remember that the contributions were already taxed.)
<59½ or <=5 yrs: Earnings taxed as ordinary income & 10% on earnings
>70½: N/A
When deciding between Traditional and Roth IRAs, the following factors are important considerations; however, since predicting one’s future tax bracket involves some degree of speculation, you might consider diversifying contributions between Traditional and Roth IRAs.
Do you expect your retirement tax rate to be higher than your current tax rate?
Does your income exceed the Traditional IRA deduction limit?
Are you covered by an employer-sponsored retirement plan?
