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Clearing the Confusion
There seems to be some confusion out there about what the differences between Individual Retirement Accounts or as they are popularily referredto as IRA's.
Both provide the same function but have different tax implications. Both types of IRA's are used for retirement but with a traditional IRA, the contributions that you make are subtracted from your gross income. At this point, taxes are then calculated. With a Roth IRA, contributions are made after taxes.
If you are able to contribute the maximum amount of $4000, this can be deducted from your gross income. At tax time, this means you will be paying taxes on less income. This is a good thing. You will have also deferred the income (the saved $4000) until retirement when it is widely assumed your income will be less as well as your tax bracket. The only thing that will affect this type of contribution is the presence of a pension plan or retirement plan provided for you at your workplace.. In all likelihood, if you have a pension, you will not be allowed to make the deduction.
Withdrawals before the age of 59 1/2 are not only penalized 10% but are also taxed at your income tax rate.
You will pay taxes on these later, when you begin your withdrawals. And you can't do that before age 59 1/2 and you must begin taking a distribution of some sort by age 70.
The Roth on the other hand, has the same maximum contribution limits as a traditional IRA and the same stipulations for redemptions. Because all contributions to the plan have already been taxed, the principal or the money you deposited into the account is yours. The only thing that is tax-deferred is any interest or dividends the investment receives.
So if you make a $4,000 contribution to your Roth, only the interest earned is taxed when the distributions are made. Any contributed money can be withdrawn at any time penalty and tax free. Take any interest earned and you will penalized the 10% for the early withdrawal and you will be taxed at your income tax rate. These plans are good for those that have a company sponsored retirement plan.
Both the Roth and traditional IRA provides for early withdrawal for circumstances.
If you deposit money into an IRA and leave it for five years, the money can be withdrawn without penalty for the following reasons:you have reached 59 1/2, you have died, you have become disabled, or it is used to help purchase a first home for you, your spouse, your kids, your grandchildren, or your parents. There is a limit on the last part, however, of ten thousand dollars.
The contributions allowed for savers older than 50 are $5,000. This catch-up provision changes in 2008 when the contribution increases to $6,000 for 50 year olds or older. Those younger than 50 will be allowed to contribute $5,000 per year in 2008.
Who can contribute to a traditional IRA? Folks who participate in an employer-sponsored retirement plan can deduct their entire contribution on their tax returns if their adjusted gross income (AGI) is $50,000 or less ($75,000 in 2006 if married and filing jointly).
If your AGI is over $60,000 ($85,000 in 2006 if married and filing jointly), and you participate in an employer-sponsored retirement plan you may not deduct Traditional IRA Contributions. If you have a tax preparer, ask them for the specific details. Often you can contribute a percentage on a sliding scale.
With a Roth IRA, you may contribute up to $4,000 -- for 2006, $5,000 if you're 50 or older and if your AGI is under $95,000 (or $150,000 if married and filing jointly).
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