Tenets of a Traditional IRA

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I’ve dedicated a lot of time to the Roth IRA and referenced the traditional (or regular IRA) many times… its about time I took a closer look at the traditional IRA. Individual Retirement Accounts are primarily self directed savings and investment accounts, as opposed to employee benefit plans.

IRA contributions

Anyone who has earned income and has not reached age 70 1/2 may make contributions to an IRA. If a husband and wife both have earned income of $4,000 or more, both can contribute up to $4,000 to an IRA. If one spouse is working and the other is not, as long as the total earned income is above $8,000, the working spouse may contribute up to $4,000 on behalf of the non working spouse.

The couple must file a joint return in order to make the $8,000 contribution and if they are age 50 or over they get an additional $1,000 contribution step-up. The IRA limits will rise to $5,000 in 2008 (for all contributors) with the $1,000 step up for those over the age of 50 intact.

Active participants

Taxpayers who are ‘active participants’ in qualified retirement plans, SEP’s, TDA’s, Simple IRA’s or a government plan may be precluded from deducting contributions to an IRA. An ‘active participant’ is defined as a person who accrues a benefit or makes an annual addition to a employer sponsored (non-IRA) retirement plan.

Along with being an active participant, a taxpayers’ contribution deductibility is only phased out (for 2007) if their AGI (adjusted gross income) is over $62,000 for a single filer or $103,000 for a married joint filer.

When the AGI for either a single or married couple falls between the two thresholds, a partial deduction can be taken. So if you’re single and make $50,000 a year and contribute to your 401K plan you can still make a $4,000 fully deductible contribution to a self directed traditional IRA.

Always remember, even if a taxpayer is not permitted to make a deductible contribution to an IRA, non deductible contributions are always allowed. In my previous post I wrote about back-dooring into a Roth IRA. If your intent is to convert a regular IRA to a Roth IRA in 2010 (or later), then making non deductible contributions now is a great alternative. See my previous post for a more detailed description on that.

Here’s a list of the key points with a traditional IRA:

• Investment income accumulates tax deferred
• You can begin to take normal distributions after age 59 1/2, distributions are always taxed as ordinary income
• Under IRS rule 72t you are entitled to begin taking qualified distributions before age 59 1/2 if the distributions are SEPP (substantially equal periodic payments)
• If distributions are taken before age 59 1/2 and are not SEPP, then there is a 10% penalty in addition to normal income taxes. There are a few exceptions including death, disability, first home purchase (up to $10,000)
• Excess contributions are penalized 6% annually until the excess is removed from the account
• You must begin to take RMD (required minimum distributions) after age 70 1/2 otherwise there is a 50% penalty applied to monies not distributed

Traditional IRA’s have always been a big part of the retirement planning landscape and will continue to play an integral part in the future…

Tags: 2010 Roth IRA Conversion Event, RMD, Roth IRA Conversion, Traditional IRA