If you’re like most of us you are not expecting social security to be your main source of income during retirement.  You know that you will need to plan for retirement, but there are so many different options and they can all be confusing.  One type of retirement plan that many tax payers take advantage of is an IRA.  There are multiple types of IRA’s.  The two most common are the Traditional IRA and the Roth IRA.  Below is a basic summary of these two types of IRA’s:

A Traditional IRA is just like a personal savings account that allows tax payers to accumulate money with tax deductible contributions.  There are a few caveats to this wonderful savings account.  Once funds are deposited to an IRA they cannot be borrowed on nor can they be withdrawn before you are 59 ½ without facing a 10% penalty.  There are also a few contribution and deduction rules that you should know about.

  1. For each individual, annual contributions are limited to the lessor of $5,500 ($6,500 if you are over 50) or their annual compensation. Items included in compensation are wages, bonuses, commissions, net income from a sole proprietor business, self-employed income from partnerships, alimony, and combat pay.  However, if you are married and your spouse does not have any of his or her own income, you are still allowed to contribute $5,500 for yourself and $5,500 for your spouse as long as your compensation is more than your contributions.
  2. The deductible portion of your contributions could also be limited or completely phased out if you or your spouse participate in retirement plan through work, like a 401K. You will face partial limitation to complete phase out of deductibility if your Modified AGI is higher than the following:
  • $61,000 for single or head of household
  • $98,000 for Married filing joint (both spouses have an employer retirement plan)
  • $183,000 for Married filing joint (only one spouse has an employer retirement plan)

A Roth IRA is, also, just like a personal savings account that allows tax payers to accumulate money.  The difference is that the contributions are not tax deductible, but the distributions are tax free, which also includes the earnings.  Though the benefit to a Roth is the tax free distributions it still has contribution limitations and distribution rules.

1. The annual contribution limits to a Roth IRA are the same as a Traditional IRA. With additional contribution phase outs for high earners:

  • Married filing joint phase out starts at $183,000
  • Single and Head of household phase out starts at $116,000

2. A Roth IRA also has rules that must be followed for tax and penalty free distributions. Tax free distributions are called qualified distributions and for your distributions to be qualified they must be held in the account for at least five years and meet at least one of the following requirements:

  • You are at least 59 ½ years old
  • The owner of the account has died or become disabled
  • The owner is taking the money out to buy their first home

One last note that applies to both Traditional and Roth IRA’s is to be careful not to over fund your IRA whether it be a Roth or Traditional, there is a 6% excise tax that will be charged on your account if it is over funded at the end of the year.