An individual retirement account (IRA) is an account that provides some tax advantages for retirement savings and is established and maintained by an individual taxpayer for his or her own benefit. There are two primary types of individual retirement accounts, traditional IRAs and Roth IRAs.

You may contribute to a traditional IRA or a Roth IRA. Your choice depends upon whether you want to save on taxes now with a traditional IRA or when you retire with a Roth IRA. Whichever account you select, you will have until tax day in April to make a contribution to your IRA for the previous year.

Traditional IRA

Traditional IRAs are IRAs to which taxpayers may make deductible and nondeductible contributions but generally the contributions are tax-deductible. Typically, contributions and investment earnings accumulated in a traditional IRA are not included in a taxpayer's income until the funds are paid out. Any transactions and earnings within the IRA have no tax impact, and withdrawals at retirement are taxed as income.

Roth IRA

A taxpayer's contributions into a Roth IRA are not deductible when made, but qualifying distributions when you are retired are not included in your gross income. Roth IRA contributions are made with after-tax dollars; all transactions within the IRA have no tax impact, similar to a traditional IRA; and withdrawals are usually tax-free. A Roth IRA must be designated as a Roth IRA when you open an account.

Eligibility

The first requirement that you must meet to by eligible to contribute to either a traditional IRA or a Roth IRA, is that you must be self-employed or employed by someone else in an activity for which you receive earned income or compensation.

In addition to the earned income requirement, you must be under the age of 70 1/2 to be eligible to contribute to a traditional IRA. Whether or not your contribution to a traditional IRA will be deductible depends on your income tax filing status and whether you or your spouse participated on any day of the year in an employer's qualified retirement plan.

  • Generally, if neither you nor your spouse participated in a 401(k) or other qualified retirement plan at work, your contribution will be fully deductible.
  • If you or your spouse participated in an employer-sponsored retirement plan, your contribution to a traditional IRA might be deductible, depending on your modified adjusted gross income (AGI).

In addition to the earned income requirement, you may be eligible to start a Roth IRA based on the amount of your modified AGI and your filing status. If you have earned income, you may contribute to a Roth IRA regardless of your age, provided your modified AGI doesn't exceed certain limits.

Maximum Contributions

The maximum for an IRA contribution in 2008 is 100% of earned income or $5,000, whichever is less, for an individual under the age of 50. Individuals aged 50 and older can contribute up to 100% of earned income or $6,000 whichever is less. This limit is for Roth IRAs and traditional IRAs, or some combination of the two. You cannot put more than $5,000 into your Roth and traditional IRA combined ($6,000 for individuals aged 50 or more under the additional catch-up contribution provisions in the law).

Deductible Catch-up Contributions for Certain Taxpayers

Taxpayers who are 50 years old before the end of a taxable year may also be entitled to make an additional deductible catch-up contribution to a traditional IRA in an amount up to $1,000. For tax years through 2009, certain taxpayers who were participants in qualified 401(k) arrangements may make additional deductible catch-up contributions up to $3,000. To be eligible, the taxpayer must have been a participant in a 401(k) plan under which all of the following occurred:

  • The employer matching contribution was made in stock and equaled at least 50% of the employees' contributions
  • The employer was a bankruptcy debtor under Title 11 of the United States Code
  • The employer was subject to indictment or conviction resulting from business transactions related to the bankruptcy case

Taxpayers who have attained age 50 prior to the close of the taxable year may also be entitled to make an additional Roth IRA catch-up contribution of up to $1,000. For tax years through 2009, certain taxpayers who were participants in qualified 401(k) plans may make additional catch-up contributions to a Roth IRA in an amount of up to $3,000. To be eligible, the taxpayer must have been a participant in a 401(k) plan under which all of the following occurred:

  • The employer matching contribution was made in stock and equaled at least 50% of the employees' contributions
  • The employer was a bankruptcy debtor under Title 11 of the United States Code
  • The employer was subject to indictment or conviction resulting from business transactions related to the bankruptcy case

Withdrawals and Distributions

Withdrawals of contributions (and income generated from those contributions) from traditional IRAs are included in a taxpayer's gross income for the year in which the withdrawal is received for federal income tax purposes. You may have to pay additional taxes, called excise taxes, if you make withdrawals from your account before you're 59 1/2 or after you're 70 1/2.

There are no required minimum distributions from a Roth IRA. Distributions made after the close of the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA for the employee's benefit are qualifying distributions which are excluded from the employee's taxable income if the distribution is any of the following:

  • Made after the employee is age 59 1/2
  • Made due to the employee's disability
  • Paid to the employee's beneficiary after the employee's death
  • Made for the purchase of a new home as long as the amount does not exceed $10,000 over the employee's lifetime

Choosing a Traditional or Roth IRA

If you are eligible for both types of IRAs and you need a tax break right now or you think that you will be paying taxes at a much lower rate in retirement, you should choose the traditional IRA. If you don't need the tax break right away, choose a Roth IRA, which is more flexible than the traditional IRA.

The advantages of a Roth IRA are:

  • It allows you to withdraw your contributions at any time, tax-free and without penalty
  • You do not have to take mandatory distributions at age 70 1/2

Questions for Your Attorney

  • Am I eligible for both a traditional IRA and a Roth IRA?
  • Which type of IRA, a traditional or a Roth, will allow me to save more money for retirement?
  • What is the maximum amount I can contribute to an IRA?