A traditional IRA could save you a significant amount in taxes. Plus, by deferring the taxes on earnings, your earnings compound even faster. Traditional IRAs offer tax-deferred earnings and the possibility for tax deductible contributions.
You can contribute to an IRA if you earn compensation and you will not reach age 70 1/2 by the end of the year. The amount you can contribute each year may be changed by the IRS and depends on your age. The amount you may deduct from your taxes is dependent upon income, marital status, and whether you are an active participant in an employer retirement plan.
You pay no tax on the deductible amounts contributed or earnings until you withdraw the funds. For most people, this is 100% of the amounts that they contributed and earned. Generally, no tax is paid on the money the year it is contributed, but it is taxed in the year it is withdrawn. If you made non-deductible contributions, you will not be taxed at time of withdrawal. You may be in a lower tax bracket in the years that you withdraw the funds, so besides deferring taxes, you may even lower your overall taxes.
If you withdraw money before age 59 1/2, you must pay a 10% penalty tax on the amount withdrawn. There are many exceptions to when this tax is due, such as if the amount is rolled over to another traditional IRA.
The year you turn 70 1/2 you must begin receiving minimum distributions. You may delay until April 1st of the following year, but you will receive two years’ worth of payments in that year if you choose to delay.
Roth IRAs provide a way to earn money tax free.
You may contribute to a Roth at any age. The maximum amount that can be contributed per year may be changed by IRS and varies by age and income. The amount contributed is not tax deductible.
You may withdraw your contributions at any time without paying income tax because you paid taxes on this money the year it was contributed. The most advantageous feature of Roth IRAs is that as long as you are over 59 1/2 and it has been at least 5 years since your first contribution, you may withdraw earnings tax free. Other conditions may also allow tax free withdrawal of earnings.
For more information about Traditional or Roth IRAs, contact us or your tax advisor, or get more information at IRS.gov.