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The “Ins” and “Outs” of IRAs

You may be able to reap tax benefits “coming in” to IRAs (individual retirement accounts) as well as “going out.” Here is a brief summary:

Putting money in: The maximum dollar amount you can contribute to an IRA for the 2005 tax year is the lesser of 100% of compensation or $4,000 (up from $3,000 for 2004). In addition, if you are age 50 or older, you can kick in an extra “catch-up” contribution of $500. The contributions may accumulate on a tax-deferred basis. Of course, there are no guarantees of earnings and you run the risk of investment loss. Also, your contribution is tax deductible if you are not an active participant in an employer-sponsored retirement plan.

The deadline for IRA contributions for the 2005 tax year is generally April 17, 2006. In other words, you can still reduce your tax liability for 2005 after the year has ended.

On the other hand, if you are an active participant in a retirement plan, your IRA contributions are nondeductible, or only partially deductible, if your adjusted gross income (AGI) exceeds a certain level. For the 2005 tax year, contributions for joint filers are phased out for an AGI between $70,000 and $80,000; and between $50,000 and $60,000 for single filers. Nondeductible contributions to an IRA are not subject to tax when they are withdrawn.

When filing a joint return and only one spouse is an active participant in a retirement plan, the other spouse can still deduct his or her IRA contribution. This deduction is phased out for a joint AGI between $150,000 and $160,000.

Taking money out: The contributions made to your IRA accumulate on a tax-free basis until they are withdrawn. At that time, the distribution is subject to tax as ordinary income. Those born prior to 1936 may be able to elect a favorable 10-year averaging on a lump-sum distribution from an IRA. You can avoid, however, current tax liability by rolling over an IRA distribution into another IRA within 60 days. A trustee-to-trustee transfer avoids the mandatory 20% tax withholding.

Generally, you pay a 10% tax penalty if you make a withdrawal from an IRA before age 59½, but there are a number of special exceptions. There is no penalty for withdrawals made due to death or disability, a series of substantially equal periodic payments, payments for deductible medical expenses, first-time home-buyer expenses (up to a lifetime limit of $10,000) or qualified tuition expenses.

Conversely, you cannot keep your money in an IRA forever. Distributions must begin no later than April 1 of the year following the year in which you turn age 70½ or the year in which you retire, if that is later.

It is important to understand all the ins and outs of these rules. With proper planning, you can maximize the tax benefits.

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	[ return to list ] The “Ins” and “Outs” of IRAs You may be able to reap tax benefits “coming in” to IRAs (individual retirement accounts) as well as “going out.” Here is a brief summary: Putting money in: The maximum dollar amount you can contribute to an IRA for the 2005 tax year is the lesser of 100% of compensation or $4,000 (up from $3,000 for 2004). In addition, if you are age 50 or older, you can kick in an extra “catch-up” contribution of $500. The contributions may accumulate on a tax-deferred basis. Of course, there are no guarantees of earnings and you run the risk of investment loss. Also, your contribution is tax deductible if you are not an active participant in an employer-sponsored retirement plan. The deadline for IRA contributions for the 2005 tax year is generally April 17, 2006. In other words, you can still reduce your tax liability for 2005 after the year has ended. On the other hand, if you are an active participant in a retirement plan, your IRA contributions are nondeductible, or only partially deductible, if your adjusted gross income (AGI) exceeds a certain level. For the 2005 tax year, contributions for joint filers are phased out for an AGI between $70,000 and $80,000; and between $50,000 and $60,000 for single filers. Nondeductible contributions to an IRA are not subject to tax when they are withdrawn. When filing a joint return and only one spouse is an active participant in a retirement plan, the other spouse can still deduct his or her IRA contribution. This deduction is phased out for a joint AGI between $150,000 and $160,000. Taking money out: The contributions made to your IRA accumulate on a tax-free basis until they are withdrawn. At that time, the distribution is subject to tax as ordinary income. Those born prior to 1936 may be able to elect a favorable 10-year averaging on a lump-sum distribution from an IRA. You can avoid, however, current tax liability by rolling over an IRA distribution into another IRA within 60 days. A trustee-to-trustee transfer avoids the mandatory 20% tax withholding. Generally, you pay a 10% tax penalty if you make a withdrawal from an IRA before age 59½, but there are a number of special exceptions. There is no penalty for withdrawals made due to death or disability, a series of substantially equal periodic payments, payments for deductible medical expenses, first-time home-buyer expenses (up to a lifetime limit of $10,000) or qualified tuition expenses. Conversely, you cannot keep your money in an IRA forever. Distributions must begin no later than April 1 of the year following the year in which you turn age 70½ or the year in which you retire, if that is later. It is important to understand all the ins and outs of these rules. With proper planning, you can maximize the tax benefits. [ return to list ]
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