IRA Basic Answers

 What is an IRA?

A traditional IRA, or Individual Retirement Account, is a tax-deferred personal retirement fund. You can contribute up to $3,000 a year at present ($3,500 if you're age 50 or older), and depending on how much you earn and your marital status, the money you invest may be tax-deductible (deductible IRA) or not (non-deductible IRA).

There are several different types of IRAs: Traditional IRA, Roth IRA, Education IRA (EDIRA), now called Education Savings Accounts, SEP-IRA, SARSEP-IRA, and SIMPLE-IRA. Traditional IRAs are broken down into Regular, and Rollover IRAs. The best part about an IRA is that your investments grow tax-free until you take the money out at retirement.

What is a Roth IRA?

A Roth IRA is a tax-deferred retirement account that turns the traditional IRA formula on its head: although retirement contributions are taxed up front, withdrawals can be made completely tax-free once you reach age 59 1/2 and have had a Roth IRA for five years.

For some people, paying taxes now to enjoy tax-free income later may actually make more financial sense in the long term. For one thing, the Roth IRA allows investors to effectively shelter more money for retirement. Although the annual contribution limit is the same for both traditional and Roth IRAs, because your Roth contribution is made with after-tax income, the full $3,000 (or $3,500 if you're age 50 or older) can compound substantially over the years — without incurring any future tax liability.

The amount you can contribute to a Roth IRA may be reduced or eliminated depending on your filing status and your adjusted gross income level.

Whether the Roth IRA is a better option really depends on your expectation of your future tax rate. In the past, retirees routinely moved into a lower tax bracket. However, with more people maintaining high levels of income even in retirement, it may make more sense to pay taxes on your contribution today, while you're still employed.

Although investors can certainly open both a traditional and a Roth IRA, most financial advisers suggest that you convert your existing account to take full advantage of the Roth's long-term benefits. But before converting, consider these factors:

You can only convert if your adjusted gross income is not more than $100,000 for the year the conversion occurs.

More importantly, you'll have to pay taxes — which can be substantial depending on how much you've amassed in your current IRA — on all deductible contributions and earnings. To avoid being hit with penalties, you must pay these taxes with non-IRA money. In fact, tax experts caution that if you don't have other cash handy to pay the tax, you're probably better off with a traditional IRA.

To see if you should open a Roth or convert your existing IRA, check out the Roth IRA Planner.

Is an IRA right for you?

As a tax-deferred investment, an IRA is a good supplement to most retirement plans. Other tax-deferred investments may be a better deal, however. First participate in your company 401(k) or 403(b), which allow larger contributions and often have a company match. Some plans also allow you to borrow from the account. An IRA beats an employer's plan only when there are poor investment choices (such as company stock) and no company match. Keoghs and SEP-IRAs are usually better for the self-employed because they allow larger contributions as well.

An ideal candidate for an IRA is someone who doesn't have a company retirement plan or whose earnings fall below the IRA ceiling. If your earnings are too high, you can still invest in an IRA, although you can't deduct your contribution. Don't invest in an IRA if you will need the money in the next few years to buy a house or start a business.

When can you open an IRA?

IRAs can be opened for a tax year from January 1 of that year until April 15 of the next year, and contributions can be made at any time along the way. This lets your money start working for you right away and allows you to fund it throughout that period. Alternately, it gives you a full 15 months to make a decision about whether an IRA is right for you.

Are you eligible for an IRA?

If you earn an income from wages or salary and you're under the age of 70 1/2 (on December 31 of this tax year), you can open a Traditional IRA.

For an Education IRA (Education Savings Account), if your adjusted gross income exceeds $190,000 (joint returns) or $95,000 (all others), the amount of contribution that you can make starts decreasing, and it disappears completely once your adjusted gross income exceeds $220,000 (joint returns) or $110,000 (all others).

Are you eligible for a Roth IRA?

There is a good chance that you can contribute to a Roth IRA, which has higher income limits and more relaxed eligibility requirements than a traditional IRA. Notably, people who are already covered by a company retirement plan are still eligible. Singles who earn less than $95,000 a year and married couples who earn less than $150,000 a year can put up to $3,000 ($3,500 if you're age 50 or older) into a Roth IRA annually. The contribution limit decreases as your income rises; singles earning $110,000 a year or married couples earning $160,000 can no longer contribute to a Roth IRA. Unlike a traditional IRA, a Roth IRA allows you to continue to contribute even after you are 70 1/2.

IRA Contributions Answers

How much can you contribute to an IRA?

You can contribute $3,000 or 100% of earned income, whichever is less. This maximum includes both deductible and nondeductible contributions. If you'll be 50 or older by the end of the year, the maximum amount that you can contribute is $3,500 instead of $3,000.

For the 2003 tax year, a married couple with only one spouse working outside the home can contribute up to $3,000 to each of two separate IRAs (one Regular, one Spousal), provided that the total amount (up to a maximum $6,000) does not exceed 100% of the working spouse’s income. The extra $500 contribution allowable for persons age 50 or older by the end of the year applies here as well.

How much of your contribution is tax-deductible from your IRA?

For Traditional and Spousal IRAs, you can fully deduct your contribution if:  

Neither you nor your spouse participated in a company-sponsored retirement plan, such as 401(k).

You contributed to a company-sponsored retirement plan and are:

Your contribution is partially deductible if you contributed to a company-sponsored retirement plan and you are:

Your contribution is not deductible at all if you contributed to a company-sponsored retirement plan and are:

Check with the IRS or your tax adviser for more information on partially-deductible contributions.

 The tax information provided is for informational purposes only and is not intended, and should not be construed, as tax advice or a recommendation. Intuit does not provide legal, tax, or investment advice and you should consult with a professional tax advisor about your individual circumstances.

Source:  http://www.quicken.com/retirement/IRA/contributions/#howmuch