What is an IRA? Who Can Contribute and How Much? What Contributions Are Deductible? When Can IRA Distributions be Taken? How Are IRA Proceeds Taxed? What About Self-Employed Individuals?
Information about a Roth IRA What is a Roth IRA? Who Can Make Contributions to a Roth? What Roth Contributions Are Deductible? When Can Roth Distributions Be Taken and How are They Taxed?
Information about an Education IRA What is an Education IRA? How Much Can I Contribute to an Education IRA? What Contributions Are Deductible? When Can IRA Distributions be Taken? How Are IRA Proceeds Taxed? What is an IRA?
An individual retirement account (IRA) is a trust created in the United States for your exclusive benefit or the benefit of your beneficiary that allows up to $2,000 of income per tax year to be deferred from current taxation (a married couple can defer a total of $4,000). Who Can Contribute and How Much?
If you have earned income in a tax year and have not reached age 70 1/2 by the end of the tax year, you can make a contribution to an IRA. Earned income includes wages, salaries, bonuses, tips, commissions, alimony, and other amounts received for performing personal services, including those performed by a self-employed individual. You can contribute the lesser of your earned income or $2,000 for any tax year. Married taxpayers filing a joint return can contribute up to $2,000 each to an IRA if : )1 each spouse has at least that amount of earned income; or 2) together, they have at least $4,000 if earned income. Maximum deductible contributions are based on the combined modified AGI of the spouses. Contributions that exceed the maximum amount allowed are subject to an access contribution penalty of 6%. Excess contributions withdrawn from the IRA before the due date (plus extensions) of the tax return are not taxed provided that no deduction is taken for the amount withdrawn. Income earned on the amount withdrawn, however, is taxable and the 10% penalty for early withdrawal applies to this amount unless an exception applies. What Contributions Are Deductible?
Contributions to an IRA are fully deductible (regardless of level income level) if neither you nor your spouse (if any) is an active participant in an employer-maintained retirement plan. If one of you is an active participant in an employer-maintained plan, no amount of the contribution is deductible if your AGI exceeds: 1) $60,000 if married filing a joint return; 2) $40,000 if single; or 3) $10,000 if married filing a separate return. A partial deduction is allowed for any category above that is lower by $10,00 or less. These limits increase in 1999. An individual not covered by an employer plan but whose spouse is covered can take a full IRA deduction if their joint AGI is less than $150,000. Joint AGI between $150,000 and $160,000 qualifies for a partial deduction. Nondeductible contributions are reported on Form 8606. While the contributions are made with after-tax dollars, the earnings accumulate tax free until distributed. If a Form 8606 is not filed, the contributions are considered to be deductible contributions. An IRA must be established and funded by the tax return filing deadline (not including extensions) for the year in which the plan is to become effective. When Can IRA Distributions be Taken?
IRA distributions can be taken any time but there is a 10% penalty on the amount distributed in addition to the regular tax if the distribution is made before you reach age 59 1/2. You must start to take distributions by April 1st of the year following the year you reach age 70 1/2 or there is a 50% penalty on the amount not distributed as required. In taking distributions, there are exceptions to paying the 10% penalty discussed earlier if:
- The distribution is a series of substantially equal payments based on your life expectancy (or your life and the life of your beneficiary ). These must continue for at least five years or until you reach age 591/2, whichever is later.
- Death or disability occurs.
- The distribution is a return of non-deductible contributions.
- The distribution is rolled into another IRA within 60 days.
- The distribution is used for medical expenses in excess of 7.5% of your AGI, regardless of whether you itemize.
- Beginning in 1998, you are a first time homebuyer or pay higher education expenses.
- The distribution is used to pay excess medical expenses or to pay health insurance premiums when you are unemployed for 12 weeks or more.
Deductible amounts contributed to an IRA will be fully taxable. For contributions of nondeductible amounts, only the earnings portion will be taxed. There are special rules for determining the taxable amount when both deductible and nondeductible amounts have been contributed to an IRA. What About Self-Employed Individuals?
Self-employed individuals can contribute to an IRA. Earned income for the self-employed is the net amount obtained form the business. Wages also count as earned income. This amount does not include amounts contributed to retirement plans or one-half of the self-employment tax. For business income amounts to count as income, personal services must have been provided to the business. If a business has a loss but there are other earnings, the loss form the business does not reduce the other earnings for the IRA contribution purposes.
What is a Roth IRA?
A Roth IRA is an individual retirement account that allows you to exclude earnings from income tax forever. While contributions are not tax deductible, the earnings will never have to be included in income if the rules are followed. Since there are no minimum distribution requirements for this kind of account, savings can be distributed as needed after the account has been held for five years and age 591/2 is reached, or passed on to beneficiaries tax free at death. Like the traditional IRA, the Roth must be established and funded by the tax return filing (not including extensions) for the year in which the plan is to become effective. Who Can Make Contributions?
If you have earned income and your modified adjusted gross income (MAGI) is less than certain limits, you are eligible to make contributions to a Roth IRA. [For the most taxpayers, MAGI is the same as adjusted gross income (AGI).] The contributions limits relative to MAGI are as follows:
| MAGI | Filing Status | Contribution |
| $95,000 or less | S, HH, QW | Full |
| $95,000-$110,000 | S, HH, QW | Partial |
| More than $110,000 | S, HH, QW | None |
| $150,000 or less | MFJ | Full |
| $150,000-$160,000 | MFJ | Partial |
| More than $160,000 | MFJ | None |
| Zero- $10,000 | MFS | Partial |
| More than $10,000 | MFS | None |
The rules are the same as for a traditional IRA except that contributions to a Roth and/or a traditional IRA in total cannot exceed $2,000 for the year per taxpayer. What Contributions Are Deductible?
All contributions are nondeductible contributions but earnings accumulate tax free in the account until distributed. When Can Distributions Be Taken?
Distributions can be taken at any time but are taxed differently depending on when taken. Unlike a traditional IRA, minimum distributions are not required from a Roth IRA at age 701/2 or any other age. Amounts in the account may remain or be distributed as desired. How Are Proceeds Taxed?
If distributions are to be tax free, earnings must be left in the account for five years beginning with the year the first deposit is made. After this five year period, distributions of earnings made after reaching age 501/2, upon death, after becoming
What is an Educational IRA?
The education IRA is a nondeductible individual account that allows $500 per year plus earnings to be accumulated for educational expenses. Distributions are both tax free and penalty free if the rules are followed. Contributions must be made by December 31st of the tax year. Who Can Make Contributions?
Contributions can be made by anyone for the benefit of a child under the age of 18 if the child has not had any funds paid for his/her benefit to a state prepaid tuition program in that year. In addition, the contributor's modified adjusted gross income (MAGI) must be within accepted limits shown below. (MAGI is the same as adjusted gross income for most taxpayers.)
| MAGI | Filing Status | Contribution |
| $95,000 or less | S, HH, QW, MFS | Full |
| $95,000-$110,000 | S, HH, QW, MFS | Partial |
| More than $110,000 | S, HH, QW, MFS | None |
| $150,000 or less | MFJ | Full |
| $150,000-$160,000 | MFJ | Partial |
| More than $160,000 | MFJ | None |
Up to $500 per year may be contributed for any one child. This is the total maximum amount no matter how many people share in the contribution. All contributions must be in cash, What Contributions Are Deductible?
The contributions to an education IRA are not deductible. Furthermore, contributions made to an education IRA during the same year a contribution is made to a state tuition program for the beneficiary results in a 6% excise tax on the education IRA amount contributed unless the contribution came from the education IRA. This same penalty applies when more than $500 is contributed during the year unless the excess is withdrawn by the due date of the contributor's tax return including extensions. When Can Distributions Be Taken?
Distributions may be taken at any time to pay qualified education expenses at an institution of higher education for the qualified child. An eligible institution is a college, university, vocational school or other qualified post secondary educational institution. Eligible expenses include tuition, books, fees, supplies, and equipment regardless of time enrolled, plus room and board for a student who attends an eligible institution at least half time. Room and board expenses are limited to $2,500 if the student lives off campus and not at home. Distributions must be made during the year in which the expenses occurred. Amounts withdrawn that exceed the amount for qualified education expenses are nonqualified distributions. How Are Distributions Taxed?
Qualified distributions (those used to pay qualified education expenses ) are free of tax for both the principal and earnings distributed. Nonqualified distributions are subject to tax on the earnings plus a 10% penalty unless they are made on account of death, disability, or funding of a scholarship (payment to a state tuition program) for the beneficiary. At the death of a beneficiary, a transfer of an account to the surviving spouse is tax free. A transfer to any other person creates a taxable event. Distributions must occur within 30 days after the death of the account beneficiary. Funds still remaining in the account when the beneficiary finishes school or reached age 30 may be withdrawn subject to tax and penalty or rolled over to an education IRA for a member of the beneficiary's family. Family members may include a son, daughter, stepson, stepdaughter, brother, sister, father, mother, stepfather, stepmother, nephew, niece, uncle, aunt, mother-in-law, father-in-law, or sister-in-law. Even a qualified distribution will not be tax free to the extent of earnings withdrawn if a Hope credit or Lifetime Learning credit is claimed for the beneficiary in the same year.
