Updated: Wed, 02/20/2013 - 01:01

Individual Retirement Accounts: Part 1 -- The Basics

Midge Hermanns, CPA, Hancock Askew
Midge Hermanns, CPA, Hancock Askew
WATCH!  ·  BiS News Video
Video updated throughout the day

The key benefit of Individual Retirement Accounts (IRAs) is that they allow your retirement savings to grow either tax-deferred or tax-free. Naturally, with the benefits come certain limitations.

With a traditional IRA, contributions are made with pre-tax dollars. Therefore, taxes are paid on earning plus deductible contributions when you take them out. This is advantageous if you anticipate being in a lower tax bracket when you withdraw your money.

You can start withdrawing from a traditional IRA at age 59½. Withdrawals are taxed as ordinary income. Contributions may be tax deductible.

With a Roth IRA, contributions are made with after-tax dollars. Therefore, there is no deduction for contributions made to this type of retirement account. However, all earnings and contributions can be withdrawn tax free after age 59½ as long as the account has been open at least five years.

Since contributions to Roth IRAs grow tax free, it is advantageous to allow the funds to grow for as long as possible.

You must have earned income in order to contribute to an IRA. Earned income for the purpose of an IRA includes wages, salaries, commissions, self-employment income, alimony and separate maintenance, as well as nontaxable combat pay.

It does not include earnings and profits from property, interest and dividend income, pension or annuity income, deferred compensation, income from certain partnerships or any amounts you exclude from income.

There is an exception for spouses who have no earned income, which is often referred to as a spousal IRA, although it is simply a rule, not a different type of account.

A spousal IRA allows the nonworking spouse to contribute to an IRA as long as a couple files a joint return and the working spouse has enough income to cover the contribution.

You must be under 70½ by the end of the year to contribute to a traditional IRA. You can contribute to a Roth IRA at any age and continue to contribute even after distributions are taken.

The maximum contributions allowed to traditional IRAs for 2013 is the lesser of $5,500 or 100 percent of employment compensation. This is slightly higher than the 2012 limit of $5,000. Individuals 50 or older can contribute an additional $1,000 annually, which applies to both 2012 and 2013.

Contribution limits to Roth IRAs are the same as traditional IRAs, but phase out when adjusted gross income (AGI) is between $178,000 and $188,000 for 2013 ($173,000 and $183,000 for 2012) for married filing jointly and qualified surviving spouse filers; $112,000 and $127,000 for 2013 ($110,000 and $125,000 for 2012) for single and head of household filers.

Married individuals filing separately who live apart at all times during the year are treated as single. Otherwise, they phase out at $10,000.

There is no upper limit on how much you can earn and still contribute with traditional IRAs. However, the amount you can deduct may be less than the limit depending on your income, filing status and whether you contribute to another IRA or participate in an employer sponsored plan such as a 401(k), profit-sharing, etc.

For married individuals, if neither spouse participates in an employer sponsored plan, both can contribute the maximum allowed.

If an individual is covered by an employer retirement plan, the deduction is phased out when AGI is between $95,000 and $115,000 for 2013 ($92,000 and $112,000 for 2012) for married couples filing jointly and qualified surviving spouse filers; $59,000 and $69,000 for 2013 ($58,000 and $68,000 for 2012) for single and head of household filers.

For married couples, if one spouse is covered by an employer retirement plan, the contribution deduction is phased out if the couple’s income is between $178,000 and $188,000 for 2013 ($173,000 and $183,000 for 2012).

The retirement savings contribution credit is available for couples filing jointly who have AGI up to $59,000 ($57,500 for 2012); $44,250 for 2013 ($43,125 for 2012) for individuals filing as heads of household; $29,500 for 2013 ($28,750 for 2012) for married individuals filing separately and single filers.

Contributions must be made by the original due date of the tax return, which is April 15. You still have some time, if you have not funded your IRA for 2012. Keep in mind that April 15 is the latest date you can contribute even if you file an extended tax return.

Required Minimum Distributions (RMD) must start by April 1 of the year after the taxpayer turns 70½ with traditional IRAs. The only required distribution from a Roth IRA is after the death of the account owner.

There is a 6 percent penalty for contributing too much and a 10 percent penalty for withdrawing funds too early, although there are exceptions to the latter. Exemptions include but are not limited to the following: becoming disabled, cost of health insurance for certain unemployed individuals, for qualified higher education expenses, to buy, build or rebuild a first home albeit a $10,000 lifetime limit applies, and certain activated reservist military personnel.

Now you know your eligibility for the various types of IRAs. In the next issue we will look at things to consider when deciding which type of IRA is best for you.

Midge Hermanns is a CPA at Hancock Askew & Co., LLP. She can be reached at 912-234-8243 or mhermanns@hancockaskew.com.

Rate This

0
Your rating: None

Explore more of Business In Savannah

 

Current weather

Broken clouds
Jobs
JOBS
Homes
HOMES
Autos
AUTOS
Savannah Deals
DEALS

Sign Up! - BiS Email Newsletter

Recent Job Postings

Loading...

Business In Savannah | business news for the creative coast