Deciding whether to open an IRA or a Roth IRA is a major decision with potentially large financial consequences. Both forms of the IRA are great ways to save for retirement, although each offers different advantages and rules.
The deadline for making a 2010 contribution to an IRA is April 18, 2011. Before you make your contribution, see which plan you are eligible for and which one meets your financial goals.
Contributions to an IRA can be tax deductible depending on your filing status, your adjusted gross income ("AGI") and whether you are covered by a retirement plan at work. Your earnings grow on a tax-deferred basis. This means that you can reinvest all of your dividends and capital gains without paying taxes on them as you go. You are also free to make changes in your account without tracking each investment’s cost basis, gain, or loss for income tax purposes.
You must have earned income to make an IRA contribution. The amount of earned income you have must equal or exceed the amount of your IRA contribution. Withdraws can begin at age 59 1/2 and are mandatory by 70 1/2. The entire amount of the withdrawal is taxed as ordinary income at regular income tax rates. Non-Deductible IRAs are available to everyone under age 70 1/2 that have earned income.
Contributions to a Roth IRA are not tax deductible.
The money you contribute to your Roth IRA grows tax-free. You do not have to pay any taxes on the earnings in the account, even when you withdraw it. This is if the account is open for at least five years and you are over age 59 1/2 when you withdraw. You must have earned income to make a Roth IRA contribution. The amount of earned income you have must equal or exceed the amount of your Roth IRA contribution.
Below are the 2010 income limitations on who can contribute to a Roth IRA:
* For single filers, your ability to contribute to a Roth IRA is phased out as your AGI reaches the range of $105,000 – $120,000.
* For married filing jointly, your ability to contribute to a Roth IRA is phased out as your AGI reaches the range of $167,000 – $177,000.
If you are eligible to make a Roth IRA contribution based on the rules above, then you can contribute to a Roth IRA in addition to your company sponsored retirement plan. There is no mandatory distribution age or required minimum distribution.
ACTION ITEM: Know the difference between an IRA and a Roth IRA.
Thomas F. Scanlon, CPA, CFP®
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