Traditional IRA

Mark Twain once said, "The rumors of my death have been greatly exaggerated." Like Mr. Twain's rumored demise, the notion that the traditional Individual Retirement Account (IRA) is no longer a useful part of a financial plan has been greatly exaggerated. Contributions to a traditional IRA continue to be a viable financial and retirement planning tool despite non-deductibility for some individuals.

All you need to make a traditional Individual Retirement Account contribution are earnings as an employee or as a self-employed person. The amount that can be contributed is the lesser of $4,000 or your earnings from your work. There is no minimum age for making a traditional IRA contribution for tax purposes. If a 16 year old works for the summer, makes $4,000 and blows it all at the mall, the tax code permits Mom, Dad or whomever to give him/her $4,000 to contribute to a traditional IRA. There is a maximum age for IRA contributions. No traditional IRA contributions may be made for people over 70 1/2, even if they are still working as hard as they were at 30 1/2.

An additional contribution of $4,000 is permitted if the traditional IRA participant has a spouse who doesn't work outside the home. The total contribution in this situation is $8,000 and the spouses can divide the amount contributed up any way they choose, so long as neither receives more than $4,000 into his/her account.

Those who reach age 50 by the end of the year can contribute an additional $500 in 2004-2005 and an additional $1,000 for 2006 and each subsequent year. In 2009 rates and catch-up contributions will both be adjusted for inflation.

The question of deductibility is often confusing to many taxpayers. There are two questions that may have to be answered to determine if a traditional IRA contribution is fully deductible, partially deductible or not deductible. The first question is: "Are you covered by a plan?" If the answer is "no," then the traditional IRA contribution is deductible regardless of the taxpayer's income. Whether or not you are covered by a plan depends on the type of employer-sponsored plan in place. If you're not sure, your employer can tell you because employers must check a box on every employee's W-2 stating whether they are covered.

If the answer is "yes" and you are covered by a plan but your spouse is not, then only you are exposed to the next test. Your spouse's contribution to a traditional IRA is fully deductible up to new phase-out limits of $150,000 to $160,000 of joint income. If both of you are covered by a plan then the next test will determine to what extent both of you can deduct your contributions.

Assuming coverage by a plan, the next question that must be answered is: "How much is your income?" For single taxpayers in 2004 with adjusted gross income (AGI) of $42,000 or less and married taxpayers who file jointly with an AGI of $65,000 or less, the contribution is fully deductible. For single taxpayers with AGI over $50,000 and married taxpayers with AGI over $70,000, no IRA deduction is permitted. For those with an AGI between those levels, the amount of the deduction is phased out proportionately. These AGI phase-out limits will be increased each year until they reach $50,000 to $60,000 for a single person and $80,000 to $100,000 for a married couple in the year 2007. There is a $200 floor to the deduction that will apply to those whose AGI is close to the upper limit.

For example, a single person who is covered by an employer's plan has an AGI (excluding the IRA deduction) of $47,000. Since that's 50% of the way from $42,000 to $52,000, he/she can deduct only $2,000 of the $4,000 contribution and the other $2,000 ($4,000 x 50%) is non-deductible.

Features

• Allows you to accumulate money for retirement, tax deferred.
• Contributions may be tax deductible.
• May be established in conjunction with a Roth IRA.

Eligibility Requirements

• Any individual who has earned compensation during the year.
• Individual must be under age 70 1/2 during the calendar year in which the contribution is made.

IRA Contributions 

• Between 2004 and 2008, limits on annual contributions for participants under age 50 are scheduled to increase from $3,000 to $5,000. The new limits will apply to the total annual contribution that a participant makes to a Traditional or Roth IRA or both.

• Employed and non-employed spouses filing joint tax returns can each contribute up to the maximum contribution limit for that year in separate IRA accounts, provided their total earned income is not less than their total joint contribution.
• Participants who are age 50 or older, can take advantage of additional catch-up contributions to their IRA plans.
• Contributions are not tax deductible.
• Eligible lower income tax payers can claim a tax credit for contributions made to the plan for tax years beginning in 2002 and ending in 2006.
• The contribution deadline is your tax filing deadline (usually April 15th), with no extensions.

*Contribution limits were established by the Economic Growth and Tax Relief Reconciliation Act of 2001 click here . Several states have not yet passed legislation to confirm their income tax laws with the provisions of the Act, including the increases in benefit and contribution limits. In order to determine whether your state has adopted conforming laws, you should consult us or your tax or financial advisor .

IRA Distributions

Distributions are not subject to a 10% federal tax penalty if the individual:

• receives the distribution after age 59 1/2;
• uses the distribution (up to $10,000) to purchase a first-time home;
• uses the distribution for qualified education expenses;
• takes lifetime equal periodic payments;
• uses the distribution for health insurance during unemployment lasting at least 12 weeks; or
• uses the distribution for deductible medical expenses.
• becomes permanently disabled; or
• dies.

All other distributions before age 59 1/2 are subject to a 10% tax penalty and federal income tax.

Required distributions must begin no later than April 1 following the year in which the participant reaches age 70 1/2.

The best part of the traditional IRA deal is the tax-deferred growth your investments will enjoy inside the account. Your earnings will grow much faster when not dragged down by the weight of a current tax bill. Your financial planner can show you whether and how a traditional IRA can fit into your retirement plan.