Individual Retirement Accounts (IRAs)
An IRA is a tax-deferred savings plan available to anyone who is employed or who receives alimony. IRA contributions are saved in a special account at a financial institution, which serves as the custodian or trustee. Most people are eligible to deduct their total IRA contributions from their income taxes. With an ordinary (traditional) IRA all or some of the contributions and all of the earnings grow tax-free until withdrawal. Those who earn too much to make deductible contributions can protect earnings from taxation by opening a Roth IRA (or if income is even higher by opening a nondeductible IRA). With a Roth IRA, contributions are not deductible, but earnings are tax free if certain conditions are met. With a nondeductible IRA, contributions are not deductible but the earnings grow tax-free until withdrawal (similar in part to that of an annuity).
Traditional IRAs were the mainstay prior to 1998. Contributions may or may not be deductible, depending on your income level, your tax filing status, and whether you use a qualified retirement plan (of which there are several, see the other retirement planning tabs of this site). Traditional IRA accounts grow tax-deferred until you begin withdrawing the money.
For 2017 and 2018, you may fully deduct up to $5,500 in IRA contributions if you are not covered by an employer-sponsored retirement plan. This deduction is available to most people even if the spouse is covered by an employer plan. If you are covered by an employer-sponsored plan, deductibility is based upon adjusted gross income (“AGI”). Only if married filing joint return’s AGI reaches $99,000 does this amount gradually reduce – up to $119,000 AGI (over this, no deduction is allowed). For single status filers it’s $62,000 AGI with gradual reduction up to $72,000 AGI. (If a spouse is covered by an employer plan and you file separately, IRA is phased out between $0 and $10,000 AGI.) In addition, $1,000 additional catch-up contributions may also be made if you are age 50 or over, for a total of $6,500 for 2017.
Please note: deadline for contributions is April 15th following the tax year. There is no extension for the contribution! (same rule applies to Roth IRA’s – and for SEP’s – see tab: “Simplified Employee Pension Plan”) this includes extension date of October 15). Ideally, one should contribute to an IRA as early in the tax year as possible. This allows the account to earn the greatest return by getting an early start. However, you can make contributions throughout the year and as mentioned, even up until April 15th of the following year. (Be careful, if you’ve delayed making a contribution for the prior year by waiting until after year end, you may need to submit a written statement to the custodian of your IRA indicating that the contribution is for the preceding year, otherwise the contribution will be applied to the year during which it is made).
Regardless, you can always contribute to an IRA even if you are precluded from deducting it. The earnings on the account remain tax deferred until the funds are ultimately withdrawn upon retirement or passed on to heirs. This is in substance similar to an annuity, where the earnings accumulate tax-free until you withdraw the funds. The key difference is the protection often afforded these retirement accounts from creditors claims.
If you are covered by an employer-sponsored plan, you may still contribute maximum amounts mentioned above, which allows your contributions to grow tax-free (again, similar to an annuity) until withdrawn. All contributions are fully taxed when withdrawn – earnings and any untaxed contributions are taxed as ordinary income at your highest “marginal” tax rate when you take withdrawals upon retirement (or earlier generally with penalties). You may begin these retirement distributions when you are age 59½ during the tax year. You must, by law, start to take withdrawals no later than the year after you turn age 70½ (based on your life expectancy factor).
If you withdraw money from an IRA before retirement age, you will probably pay taxes plus a 10% penalty. You can avoid this penalty in certain situations. There are exceptions to the 10% penalty as follows: death of the IRA owner, disability, periodic payments, certain medical expenses, qualified higher education expenses and a qualified first-time home purchase.
Spousal IRA is for a spouse with little or no earned income and no retirement plan at work. You may also contribute up to $5,500 (or up to $6,500 each with catch-up contributions, when 50 years old by year-end) to IRAs for both the earner and spouse (and so: $11,000 total, or $13,000 with catch-ups) as long as this amount is not more than total earnings for the year. The spouse using a spousal IRA may deduct these contributions, up to $5,500 per year, if the earner does not have a retirement plan at work.
Even if the working spouse has an employer retirement plan, the spousal IRA deduction is not phased out until joint AGI is between $186,000 and $196,000. The rules are varied, and I would be glad to discuss these rules with you if you have any questions.