The time for filing income tax returns is just around the corner. This is the time of year when we hear about IRAs almost a hundred times a day. Many of us wonder what they’re all about. If we don’t know what an IRA is, how can we decide to open one?
An IRA or individual retirement account is a long-term savings and investment account, designed to help us save for our “golden years”. There are two types of IRA: deductible and non-deductible (also known as ROTH IRA). The deductible IRA allows you to deduct all of your contributions on your income tax return. That’s why everyone wants one before April 15!
Why can one be deducted and not the other? The difference is that with the deductible IRA, principal and earnings are not subject to taxes until you take the money out, generally after the age of 60. With the non-deductible IRA, contributions cannot be deducted from income tax returns, and when you take the money out, generally after age of 60, the principal and earnings are not subject to income taxes.
Thus, the decision of opening an IRA may be based on how much income tax relief you need now versus if you can live without the income tax deduction now and then avoid paying taxes when the money is distributed to you. Regardless of which IRA you choose, it is a very valuable instrument that can help increase your financial tranquility during your retirement years.
Keep in mind these pointers about IRA accounts:
- You may open an IRA if you are younger than 75 and generate income from wages or self-employment.
- In the case of deductible IRAs, you may deduct up to $5,000 of your contribution from your income tax return. If you’re married, your spouse may also contribute to an IRA even if he or she does not generate income. Thus, a married couple may deduct up to $10,000 in their income tax return.
- If you withdraw the money from an IRA before the age of 60, you may have to pay the Treasury a 10% penalty. The exceptions that apply include: loss of employment, death, purchase of your first home, payment of your children’s college tuition, rollover to another IRA, losses due to natural disasters, and the purchase of a computer.
- Not all IRAs are the same. Depending on the type of IRA and who offers it (a bank, an insurance company or a brokerage firm) they may or may not guarantee the principal and yield.
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