There are many different types of retirement savings available. An individual retirement arrangement, also known as an IRA, is one type of personal savings which can be favorable at tax time. There are a few different kinds of IRA savings, including traditional and Roth IRAs. Typically, IRAs are arranged with a bank, insurance provider, or other financial institution.
Some contributions to a traditional IRA may qualify for a deduction at tax time. Also, you may qualify to receive a tax credit equivalent to a specific percentage of your contribution. Traditional IRAs generally are not subject to taxation until they are distributed. IRAs are individually owned, and cannot contain joint ownership, although you can list a beneficiary to receive amounts in the event of death.
In order to make contributions to a traditional IRA, you have to be younger than 70 ½ by the end of the tax year. You are also required to have accrued taxable income, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment. Certain compensation payments, such as taxable alimony and other individual maintenance payments, are considered taxable income for IRA purposes.
Certain income that does not count toward taxable compensation for IRAs include:
- Earnings or profits from property (rental income)
- Interest or dividend income
- Pension or annuity income
- Deferred compensation
In order to calculate your allowable deduction, you’ll need to use worksheets provided in your Form 1040. IRA deductions cannot be claimed by filing a Form 1040EZ. If none of your contributions are deductible, you should attach Form 8606, Nondeductible IRAs, to your tax return. Form 8880, Credit for Qualified Retirement Savings Contributions, will help you figure out whether or not you qualify for a tax credit.
Traditional IRAs are either fully or partially taxed in the year in which distributions were received. If all contributions you made were deductible, than your distributions will be fully taxed.
Any distributions received before the age of 59 ½ may be subject to an additional 10% tax. Once you reach the age of 70 ½, you should begin receiving minimum distributions in order to avoid specific excise taxes.
Roth IRAs are different from traditional IRAs in the following ways:
- Contributions are NOT deductible
- Qualified distributions are not taxed
- There is no age limit for contributing
- Designation of a Roth IRA must occur during setup of the IRA account
