The ABC’s of IRA’s

By Allison Eklund

Allie Eklund
Allison Eklund

With tax season in full force, it’s time to brush up on the ABC’s of IRA’s. Both traditional and Roth IRA’s are retirement savings vehicles that can help you plan for the future. Not sure which one may be right for you? Here’s the 411:

A Roth IRA or a Traditional IRA?

Traditional IRA’s are tax deductible, while Roth IRA’s are nondeductible.

Remember traditional IRA’s hold pre-tax money, whereas Roth IRA’s hold post tax money. Why does this matter?

If you are in a low tax bracket now, but anticipate having a higher tax bracket later, a Roth IRA may benefit you. Roth IRA’s tax your contribution now at your current tax rate, and then come retirement when you anticipate being in a higher tax bracket, qualified Roth distributions are tax free.
Putting money into a Traditional IRA may directly lower your taxable income for the contributing year. Example? If your income for 2015 was $55,000 and you decide to max out your traditional IRA- your taxable income now becomes $49,500.00. Let’s flip the script and show the Roth example: Your income for 2015 was $55,000.00 and you decide to max out your Roth IRA. Your taxable income still remains at $55,000.00

But what if I have a retirement account at work?

You may still be able to open and invest in either a Traditional or Roth IRA. Depending on how much you earn, you may not receive a tax deduction for your Traditional IRA contribution. If you’re covered by a retirement plan at work, check out this chart to see if you are able to defer additional money in a Traditional IRA to save on income taxes.

Contributions.

Contribution limits are the same for both Traditional and Roth IRA’s. Below the age of 50? Currently, you may invest up to $5,500.00 in either a Traditional or Roth IRA. If you’re above the age of 50, you may invest an additional $1,000.00 as a “catch up” contribution. You may not invest more than the contribution limit per year, even if you have both a traditional and Roth IRA account.
You may always withdraw your exact contribution amounts from your Roth IRA tax and penalty free. Rules for distributing contributions from a Traditional IRA are different.

Distributions.

In most cases, distributions from a Traditional IRA will be treated as “ordinary income” meaning you will pay taxes on the distributed amount. Additionally, if you’re below the age of 59 and 1/2, you will also pay a penalty fee of 10%.Yikes! Try to keep that money in your IRA until retirement.
If you must withdraw from your IRA, there is a small list of exceptions to avoid the 10% penalty, see the full list of penalty free distributions here.
Conversely, qualified distributions from Roth IRA’s are tax-free. See what qualifies as qualified here. If you are below the age of 59 and ½, and are taking early distributions, you may have a 10% early withdrawal penalty assessed on your distribution.

Eligibility.

Know your MAGI- that’s Modified Adjusted Gross Income. At certain MAGI levels, you may become “phased out” of eligibility for contributing to a Roth IRA. For 2016 phase out limits, check here to see if you’re still eligible.
If you’re already phased out, there is still hope. Participating in a 401(k) plan? If your employer’s plan offers a “Roth provision,” contributions do not have phase out limitations.

 

Allison Eklund offers securities and advisory services through KMS Financial Services, Inc.

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