Planning For Retirement With IRA’s

While retirement plans benefit from special tax advantages, they are also restricted by special tax regulations. For example, you are allowed a tax break if you contribute to a retirement plan and you are able to have your retirement income grow free of taxes (for a certain period of time). However, annual contributions, the total size of each contribution, and the frequency of contributions are subject to restrictions. It is important that you carefully consider your options before deciding on a retirement plan. There are generally two categories to choose from, IRAs and employer-sponsored plans.

Before you can start planning, review the retirement plans that are currently available to you. Generally, there are two categories into which all plans can be sorted: IRAs and employer-sponsored plans. IRAs are perhaps the most widely used retirement plans because they’re easy to set up and maintain. You can open up one yourself it doesn’t have to be sponsored by your employer and you can contribute as much (or as little) as you want, whenever you want, provided you don’t exceed applicable annual limits. Following are descriptions of the three main types of IRAs:

Traditional IRA Options. IRA assets grow tax deferred, meaning that you owe no tax on the earnings until you withdraw funds.

Contribution eligibility depends on earned income, statutory limits, and age. You can only contribute, at a maximum, as much as your earned income. Earned income is defined as income from wages and self-employment income in the period of one year. Earned income does not include investment income. If you are age 50 or older then you may also be allowed to contribute what are called catch-up contributions. Additionally, your spouse can also use your income to make contributions of his or her own. However, you and your spouse are only eligible for make contributions if you have not reached age 70 at the end of the year of the said contribution.

Considering other options besides the traditional IRA may be in your best interest.

The deductibility of your contribution is one factor that may make you lean towards once type of IRA over another. Your income level, along with other factors, will determine if a contribution to a traditional IRA will be fully deductible. If both you and your spouse are able to participate in a plan that is sponsored by one of your employers, you are automatically able to deduct your contribution, regardless of how much income you earn. However, your adjusted gross income (AGI) might make your deductions value reduced or even worthless.

If you aren’t eligible to make a deductible contribution (or a Roth IRA contribution), you may wish to make a nondeductible one you’ll still enjoy the benefit of tax-deferred growth. And, when you withdraw the funds after age 591/2, only the earnings will be taxed. You can withdraw your nondeductible contribution without tax.

Roth IRA. A Roth IRA and a traditional IRA have the same contribution amounts. The difference between these two plans is the eligibility rules. A Roth IRA has no age limit with respect to contributions. However, you are only allowed to escape the age limit if you meet the earned income requirement.

You also must remember that the total annual contributions to your IRA may never exceed the defined limit. In order to get around these limits you are able to split your contribution between a traditional and Roth IRA.

The Roth IRA also differs from a traditional IRA in that you won’t be able to claim a deduction for your contributions. But all Roth IRA earnings can be withdrawn tax free after age 591/2, provided you’ve had the account for at least five years. (You can withdraw amounts up to your total contributions tax free at any time.)

There are other differences as well. Traditional IRAs have required minimum distribution rules that must be strictly followed. Roth IRAs have no distribution requirements during your lifetime.

The exact formula for calculating the contribution amount is very complicated. However, if you were to use 20% of your net self-employment earnings as a guess it would be a close estimate.The formula for calculating the exact contribution amount is too complex for our purposes, but a rough estimate of 20% of your net self-employment earnings is a good start.

Simplified Employee Pension SEP IRA. A SEP IRA is made for entrepreneurs. It enables them to make larger contributions than would otherwise be allowed by a traditional or Roth IRA. The tax rules for a SEP are the same as the other two types of IRA?s.

This data is distributed for informational purposes only; Doeren Mayhew is not rendering legal, accounting, or other professional advice or opinions and assumes no legal responsibility. Contact Doeren Mayhew for more information.

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