Everything You Need to Know about IRAs
IRA, – it’s an acronym we hear a lot, but what is it really? With Tax Day- aka the deadline to make 2018 IRA contributions, just around the corner, now is a great time to brush up on your IRA facts.
IRA stands for Individual Retirement Account. It is an account to help you build your retirement savings.
The IRA itself is not an investment, it’s just the tax-advantaged home for your funds and annual contributions to live in. Contributions are typically made annually, in accordance with the IRS’s annual contribution limit. For 2018 contributions the limit is $5,500, plus an additional $1,000 catch up contribution if you are 50 or older.
Once you’ve opened your IRA you can use the money you contribute to it to purchase investments such as stocks, mutual funds, or bonds – just like you would with any other investment account. From those investments, your money can grow- typically at greater rates than if it was just sitting in a savings account at your bank.
So why should you open an IRA?
The main advantage of an IRA over other investment accounts are the tax benefits. Both Traditional and Roth IRAs (the two most common varieties) offer the potential for tax-advantaged growth.
Contributions made to a Traditional IRA are tax-deductible in the year they are made up to IRS limits. That money will not be taxed until the account owner withdraws it during retirement.
Roth IRA contributions are not tax-deductible, but withdrawals from Roth accounts will not be taxed if the account owner is over the age of 59 ½ and has held the account for at least five years.
Whether you can deduct your traditional IRA contribution depends on your income level, marital status, and coverage by an employer-sponsored retirement plan. For instance:1
- If you are single and covered by an employer-sponsored retirement plan, your traditional IRA contribution for 2018 will be fully deductible if your AGI was $63,000 or less. The amount you can deduct begins to decline if your AGI was between $63,000 and $73,000. Your IRA contribution is not deductible if your income is equal to or more than $73,000.
- If you are married, filing jointly, and the spouse making the IRA contribution is covered by an employer-sponsored retirement plan, your 2018 IRA contribution will be fully deductible if your combined AGI is $101,000 or less. The amount you can deduct begins to phase out if your combined AGI is between $101,000 and $121,000. You may not claim an IRA deduction if your combined income is equal to or more than $121,000.
- If you are married, filing jointly, and your spouse is covered by an employer-sponsored plan (but you are not), you may qualify for a full IRA deduction if your combined AGI is $189,000 or less. The amount you can deduct begins to phase out for combined incomes of between $189,000 and $199,000. Your deduction is eliminated if your AGI on a joint return is $199,000 or more.
- If neither you nor your spouse is covered by an employer-sponsored retirement plan, your contribution is generally fully deductible up to the annual contribution limit or 100% of your compensation, whichever is less.
Keep in mind that contributions to a Roth IRA are not tax deductible under any circumstances.
You may begin withdrawing money from a traditional IRA without penalty after age 59½. Generally, previously untaxed contributions and earnings are taxable at the then-current regular income tax rate. Nondeductible contributions are generally not taxable because those amounts have already been taxed.
You must begin taking required minimum distributions, also known as RMDs, from your traditional IRA no later than April 1 of the year following the year you reach age 70½ and then annually thereafter. If your distributions in any year after you reach 70½ are less than the required minimum, you may be subject to an additional federal tax equal to 50% of the difference.
Unlike traditional IRAs, Roth IRAs do not require the account holder to take RMDs during his or her lifetime. This feature can prove very attractive to those individuals who would like to use the Roth IRA as an estate planning tool.
One potential area of confusion around IRAs concerns an individual's eligibility to make contributions. In general, tax rules require that you must have compensation to contribute to an IRA. Compensation includes income from wages and salaries and net self-employment income. If you are married and file a joint tax return, only one spouse needs to have the required compensation.
With regard to Roth IRAs, income may affect your ability to contribute. For the 2018 tax year:
- Individuals with an adjusted gross income (AGI) of $120,000or less may make a full contribution to a Roth IRA.
- Married couples filing jointly with an AGI of $189,000 or less may also contribute fully for the year.
- Contribution limits begin to decline, or "phase out," for individuals with AGIs between $120,000 and $135,000 and for married couples with AGIs between $189,000 and $199,000. If your income exceeds these upper thresholds, you may not contribute to a Roth IRA.2
If you are interested in learning more about opening an IRA or making your 2018 IRA contributions by the April 15 deadline, please do not hesitate to contact us.
This communication is not intended as
1Internal Revenue Service, Notice 2017-64.
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