The Individual Retirement Account (IRA) is one of the most widely used types of retirement accounts. Two types of IRA accounts exist, the Traditional IRA and the Roth IRA. Here are the basics on each.
Traditional Individual Retirement Account (IRA)
A Traditional IRA is a retirement account in which contributions and earnings grow tax-deferred. Contributions may or may not be tax-deductible, depending on income and employer retirement plans. Distributions are taxable, although after-tax contributions are not taxed when distributed.
Contributions are limited to the smaller of $5,000 or the amount of your taxable compensation for 2011. Those age 50 or older may make a “catch-up” contribution as well. The catch-up contribution is limited to $1,000 for 2011, for a total of $6,000.
Contributions are tax-deductible for individuals or couples if no employer retirement plans are available. Otherwise for 2011, tax-deductibility is phased out for individuals with adjusted gross income (AGI) of $56,000 to $66,000, or for couples filing jointly with AGI of $90,000 to $110,000. If one spouse has an employer retirement plan, and the other does not, phaseout is between $169,000 and $179,000. Those not eligible to make tax-deductible contributions may still make after-tax contributions to an IRA account, regardless of income.
Distributions prior to age 59½ are subject to a 10% penalty tax (some exceptions apply) as well as ordinary income tax. Distributions after age 59½ are subject to ordinary income tax. Mandatory distributions must begin before April 1st of the year following the year in which the IRA holder turns 70½.
Roth Individual Retirement Account (IRA)
A Roth IRA is a retirement account in which contributions and earnings grow tax-free. Contributions are not tax-deductible, and are made with after-tax earned income. Distributions are tax-free provided the following requirements are met:
- Five years have elapsed since the initial contribution, and
- The distribution is due to:
- Attainment of age 59½;
- Death or disability, or
- First home purchased (limited to $10,000).
Contribution limits and catch-up contribution limits are the same as the Traditional IRA for 2011.
For 2011, eligibility for Roth contributions is limited to individuals with AGI of less than $107,000, or for couples filing jointly with AGI of less than $169,000. Partial Roth contributions are available to those in the AGI phase out ranges (for individuals $107,000 to $122,000, for couples filing jointly $169,000 to $179,000).
Roth IRAs are not subject to mandatory distribution rules and contributions can continue regardless of age. This benefits the investor with sources of income other than an IRA and can make the Roth IRA an estate-planning tool as well.
Our Advice
Henssler Financial recommends making a Roth IRA contribution if you are eligible. If you are not eligible, in most cases, you are probably better off avoiding a Traditional IRA contribution with after-tax dollars, with a few exceptions. If you are a frequent trader, the Traditional IRA allows you to realize capital gains without paying capital gains taxes at the time you sell. Also, if you have most of your assets in taxable accounts, a small portion added to an IRA gives you some diversity, just in case tax law changes in the future make the Traditional IRA more attractive. Otherwise, under current tax law, you are probably better off investing funds in a taxable account. Of course, as tax laws change, so will these recommendations. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
