Individual retirement account (IRA), the tax deductible of contributions — has strict eligibility requirements based on income, filing status, and availability of other retirement plans (mandated by the Internal Revenue Service).
Transactions in the account, including interest, dividends, and capital gains, are not subject to tax while still in the account, but upon withdrawal from the account, withdrawals are subject to federal income tax (see below for details). The traditional IRA also has more restrictions on withdrawals.
According to IRS pension/retirement department as of July 13 2009, Traditional IRAs (originally called Regular IRAs) were created in 1975 and made available for tax reporting that year as well. Information pertaining to them from 1980 through the present is available at the IRS.gov website. by reviewing the instructions for the form 1040. The original contribution amount in 1975 was limited to $1,500 or 15% of the wages/salaries/tips reported on line 8 of the Federal form 1040 (1975).
Traditional IRA contributions are limited as follows:
|
Year |
Age 50 and Below |
50+ Catch-up Contribution |
|
2018 |
$5,500 |
$1,000 |
|
2019 |
$6,000 |
$1,000 |
|
2020 |
||
|
2021 |
Advantages:
The contributions are tax-deductible, lower the tax bracket, the taxpayer gets the tax benefit immediately.
With a Traditional IRA, one always has an option to convert to a Roth IRA.
Tax deferred during the contribution period, and have an opportunity to gain capital
Disadvantages
One must meet the eligibility requirements to qualify for tax benefits.
All withdrawals from a Traditional IRA are included in gross income and subject to federal income tax (with the exception of any nondeductible contributions; there is a formula for determining how much of a withdrawal is not subject to tax)
Withdrawals must begin by age 70½ ( by April 1 of the calendar year after age 70½ is reached) according to a complicated formula. If an investor fails to make the required withdrawal, half of the mandatory amount will be confiscated automatically by the IRS.
The IRS will also assess a 10% early distribution penalty if the participant is under age 59½.
Income limits:
All taxpayers can make IRA deposits and defer the taxation of earnings. However, as explained below, the deposits are not deductible from income under certain circumstances. Accordingly, traditional IRAs are sometimes referred to as either "deductible" or "non-deductible."
If a taxpayer's household is covered by one or more employer-sponsored retirement plans, then the deductible of traditional IRA contributions are phased out as specified income levels are reached (Modified Adjusted Gross Income is between).
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The lower number represents the point at which the taxpayer is still allowed to deduct the entire maximum yearly contribution. The upper number is the point as of which the taxpayer is no longer allowed to deduct at all. The deduction is reduced proportionally for taxpayers in the range. Note that people who are married and lived together, but who file separately, are only allowed to deduct a relatively small amount.
To be eligible, you must meet the earned income minimum requirement. In order to make a contribution, you must have taxable compensation (not taxable income from investments). If you make only $2000 in taxable compensation, your maximum IRA contribution is $2000.
Converting a Traditional IRA to a Roth IRA.
Conversion of a Traditional IRA to a Roth IRA results in the converted funds becoming taxed in the year they are converted (with the exception of non-deductible assets).
Prior to 2010, two circumstances prohibit a conversion to a Roth IRA: Modified Adjusted Gross Income exceeding $100,000 or the participant's tax filing status is Married Filing Separately. With recent legislation, as part of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), the modified AGI requirement of $100,000 and not be married filing separately criteria was removed in 2010.