If you have an IRA, you could potentially get a tax deduction for contributing to this account. It is already a good idea to invest in your retirement, but it is even better when you pay less tax due to your investment! You can choose to contribute to a traditional IRA or a Roth IRA, and both have different tax implications.
If you contribute to a Roth or traditional IRA, the limits are the lesser of $5,500 per year ($6,500 if you are age 50 or older) OR your taxable income. Many people have one account or the other. However, if you have both accounts the contributions differ. If you have both accounts, the amount you are allowed to contribute to a Roth IRA stays the same, but is reduced by the amount you contribute to your traditional IRA. For instance, if you contribute $3,000 to your traditional IRA, then you can contribute $2,500 ($3,500 if you are 50 or older) to your Roth IRA. Roth and traditional IRAs are also taxed differently.
If you contribute to a traditional IRA, your contributions may be deductible. You may be able to receive a deduction for the full amount contributed ($5,500 or $6,500) or your deduction may be phased out based on your AGI. If you and your spouse are not covered by an employer retirement plan, your contributions up to the allowed limit are deductible regardless of your AGI. If you are covered by a retirement plan, your deduction allowed is phased out as follows (The numbers in parentheses refer to 2015 tax year AGI limitations):
|Filing Status||AGI||Deduction Allowed|
Head of Household
|Below $60,000 ($61,000)||Full contribution is deductible|
|Between $60,000 ($61,000) and $70,000 ($71,000)||Deduction is phased out|
|Above $70,000 ($71,000)||Deduction disallowed|
|Married filing jointly
or qualifying widow
|Below $96,000 ($98,000)||Full contribution is deductible|
|Between $96,000 ($98,000) and $116,000 ($118,000)||Deduction is phased out|
|Above $116,000 ($118,000)||Deduction disallowed|
|Married filing Separately||Below $10,000||Deduction is phased out|
|Above $10,000||Deduction disallowed|
Even if your deduction is phased out, you can still contribute up to the $5,500 or $6,500 limit. If a portion of your contribution is disallowed, you need to file Form 8606. This designates your contributions as nondeductible. Even if you are not required to file a tax return, you still must file this form with the IRS. By filing this form, it helps the IRS keep track of all contributions you have made to an IRA that haven’t been deducted on your return. When you take a distribution from your IRA, you do not have to claim that distribution in your taxable income up to the amount that you had nondeductible contributions. If you fail to file this Form with the IRS over the years, distributions you take from your traditional IRA will be taxed as ordinary income whether or not you had previous nondeductible contributions. You can also claim a all or a portion of you IRA contribution as nondeductible even if it could be deductible.
Contributions to Roth IRAs are not deductible on your tax return. However, they are generally not taxed when you receive qualified distributions. A distribution is qualified if it was made after a 5 year period that begins with the first taxable year that you contributed to your Roth IRA, and the distribution was taken on or after you turned 59 1/2, the distribution was taken because you were disabled, or because a distribution was made to your beneficiaries after your death. If you meet the 5 year requirement and one of three requirements listed, your distribution will not be taxed.
On the other hand, traditional IRA contributions can be used as a deduction as discussed above. However, when you take a distribution from your IRA, it will be included in income and you will be taxed on it. For both Roth and traditional IRAs, if your distribution is taken before you turn 59 1/2 and you are not disabled or distributing funds to your beneficiaries, then you could be charged a 10% early distribution penalty when you file your tax return that year.
Not only can you be penalized for taking money out of your IRA too soon, but you can also be penalized for putting money into your IRA. If you are 70 1/2 or older, you can no longer put money into your traditional IRA. This does not apply to Roth IRAs; you can contribute to your Roth IRA regardless of age. If you do, you will be penalized 6% per year until you withdraw the amount you contributed and any earnings made on that amount. Additionally, if you put more than the allowed limit ($5,500 or $6,500) into your Roth or traditional IRA, you will be penalized at 6% until you remove that money and earnings made on that amount.
At 70 1/2 you are required to begin taking required minimum distributions from your IRA. This does not apply to Roth IRAs. A required minimum distribution is the minimum amount that you are required to take from your IRA during a certain tax year. This in theory is to make you withdraw most or all of your money before you die so there is not a huge balance sitting in the account. Click here to see the worksheet you can use to figure out if you need to take a required minimum distribution.
Contributions to you IRA can be made for the 2014 tax year until April 15, 2015, and April 15, 2016 for the 2015 tax year. Additionally, if you contributed too much money, you have until April 15th to remove that money and any earnings without being penalized.
Happy retirement saving everyone! Please comment below with any questions!