Round 1: Eligibility and Deductibility
Anyone under the age of 70½ who has earned income is eligible to contribute to a traditional IRA. Contributions may be tax deductible, depending on your income level and active participation in a qualified retirement plan through your employer. The potential earnings in these accounts grow tax deferred until you withdraw your funds, at which time they are taxed as ordinary income.
The Roth IRA is a nondeductible IRA that allows tax-deferred earnings accumulation and tax-free qualified withdrawals. Unlike traditional IRA distributions, qualified distributions from a Roth IRA are not included in gross income. Tax-free qualified distributions apply not only to the owner but also to Roth account beneficiaries.
Round 2: Contributions
Currently, the annual contribution limit to traditional and Roth IRAs combined is $5,500 per person. If both spouses work, each can contribute the maximum annual contribution limit, as long as the amount contributed does not exceed joint earned income. If only one spouse works, a spousal IRA may allow the couple to contribute the maximum amount for each individual, as long as the amount contributed does not exceed earned income. Workers ages 50 and older may make additional $1,000 catch-up contributions to their IRAs.
Round 3: Distributions
Traditional IRAs are subject to mandatory distributions that must begin once you reach age 70½. The first distribution must be taken no later than April 1 of the year after you turn 70½. In succeeding years, annual minimum distributions must be taken no later than December 31. If you do not comply with this rule, you are subject to a 50% federal income tax penalty on the amount you should have withdrawn. In addition, there may be a 10% federal income tax penalty if you withdraw funds prior to age 59½.
Tax-free qualified Roth IRA distributions must meet the five-year holding requirement and take place after the owner reaches age 59½. Exceptions include the owner’s death or disability or a qualifying first-time homebuyer’s expenses ($10,000 lifetime cap). Eligibility to contribute to a Roth IRA phases out at higher modified AGI levels, and qualified distributions may be subject to state and local taxation. Another benefit is that you can contribute past age 70½ if you have earned income. You do not have to take required minimum distributions due to age from a Roth IRA (Roth IRA beneficiaries, however, do have to take RMDs).
So, who is the “winner” you ask? That depends on each individual’s situation. If you would like us to take a look at your circumstances in order to declare a winner for your retirement savings, please let us know using the Contact page of our website.
Until next time, cheers!
Jim