Previously, we discussed how enrolling in a Roth IRA (independent retirement account) could get you on the road to the strong and sexy retirement that you deserve. However, what happens if you do not meet the qualifications for a Roth IRA? Well, ladies and gentlemen, no fear: a Traditional IRA is just what you need to get your financial house in order!
What is a Traditional IRA?
The Traditional IRA was created with the passage of the Employee Retirement Income Security Act in 1974. This investment vehicle allows you to secure a tax-deferred savings and investment account outside of those provided to you through your employer. Once you establish an IRA, your money will grow, tax-deferred, until you receive a distribution (withdraw from the account). An individual under the age of fifty can contribute $5,500 per year. Individuals over the age of 50 are eligible to contribute $6,500 per year.
There is an April 15th deadline for opening an IRA account for the previous tax year. For example, you could open up a Traditional IRA account on April 1, 2015 for the 2014 tax year and make a full contribution ($5,500 or $6,500 depending upon your age). I do not advise waiting until the last minute. because you will miss an entire year of compounding interest.
Who Qualifies and What are the Income Thresholds for a Traditional IRA?
The IRS has rules and regulations when it comes to contributions and distributions of your retirement money.
- An individual can contribute to a Traditional IRA up to the age of 70.5 and must have earned income, which includes wages, tips, bonuses, commission, and self-employment income, to name a few.
- Married taxpayers who file jointly can also contribute to an IRA for a non-working spouse. According to the IRS, if you are married/filing jointly and earn $193,000 or more per year you qualify for a Traditional IRA.
- If you are single and earn $131,000 or more per year you also qualify for a Traditional IRA. These figures are up from tax year 2014 due to cost of living adjustments.
An Item for Consideration
You may be able to deduct part or all of your Traditional IRA contribution on your tax returns, but this amount depends on how you are filing your tax return and whether you are covered by an employer-sponsored retirement plan.
If you are covered by a retirement plan through your employer, and your Modified Adjusted Gross Income (MAGI) exceeds a specified IRS income limit, you can’t deduct your contribution. Please consult the IRS website, a tax professional or financial advisor, as this can be tedious and cumbersome information to process and fully understand.
Distributions, Taxes, and Penalties
You must begin to take a Required Minimum Distribution (RMD) at 70.5 years of age; in layman’s terms, this means you have to start withdrawing from the account and stop contributing to it. The RMD occurs yearly and is typically the account balance at the end of the previous year divided by a distribution period that is provided by the Uniform Lifetime Table (another table provided to us by the IRS).
What would a money lesson be without talking about taxes and penalties? If you wish to withdraw any of your Traditional IRA contributions prior to 59.5 years of age, you will incur an additional 10% tax. Additionally, if you contribute to the IRA in excess and do not withdraw the excess prior to the date that your tax return is due, you will be hit with a 6% penalty.
Traditional IRAs provide some of the great features that are present in Roth IRAs. However, they can be tricky if you do not understand the ins and outs of qualification, contribution deductions, and taxes. The information that I have provided is not all inclusive, but I wanted to give you some points of consideration prior to talking to a professional about this retirement savings vehicle. I believe that if you fully understand where you money is going and how it works, you can make a solid decision.
Are you still a fan of the Roth IRA (my favorite), but due to income limits, qualify for the Traditional IRA? No sweat! Next month we will talk about how to convert your Traditional IRA to a Roth IRA.
Amanda Golsch is a six year employee of Children’s Hospital Medical Center and an adjunct professor for the University of Cincinnati. While in grad school, Amanda developed a passion for personal finance. She realized that personal finance can impact every aspect of your life, including your health. Therefore, Amanda has set out to teach as many women as possible basic financial principles that can leave a powerful and lasting impact. Her motto is “A financially literate woman is a powerful woman.” Got a question for Amanda? Write to firstname.lastname@example.org.