IRA

Traditional IRA

A traditional IRA is an individual savings plan. The contributions you make are set to a specified limit with the contribution considered tax-deductible. Money invested and earned in a traditional IRA will be subject to income taxes when you withdraw it. Once you reach the age of 59 1/2 years of age withdrawals can be made without penalty. You must begin mandatory withdrawals from your account when you reach the age of 70 1/2. A traditional IRA must be established with an IRS-approved institution such as banks, credit unions, or brokerages. A traditional IRA can be created at any time during the year but contributions for a tax year must be made before the tax filing deadline.

The Advantages of a Traditional IRA

Contributions are tax-deferred
Investment income is not taxed until withdrawn

The Disadvantages of a Traditional IRA

Early withdrawals greater than contributions are fully taxable and subject to a 10% penalty

Contributions limits typically change each year for every individual

Mandatory withdrawals must begin when you turn 70 ½ years of age

Failure to make withdrawals as scheduled or not taking the required withdrawal will result in penalties

After reaching age 70 ½, contributions can no longer be made

Your heirs will owe taxes on earnings

Distribution Rules
If you own several traditional IRAs, they are treated as a single account when calculating the tax consequences of distributions from any of your accounts. A 10% penalty is assessed in addition to income taxes when you withdraw money early.

Roth IRA

A Roth IRA is also an individual savings plan. You can make nondeductible contributions up to the established limits. Tax-free withdrawals are available within certain limitations. Withdrawals can be made without penalty when you reach the age of 59 ½ and funds have been in your account for at least 5 years. After you reach the age of 70 ½, you can continue contributing to your Roth IRA.

Roth IRAs must be established with an IRS-approved institution such as banks, credit unions, or brokerages. Upon setting up a Roth IRA, you will receive several documents including, the IRA statement disclosure statement, the IRA adoption agreement, and the plan document. A Roth IRA can be created at any time during the year but contributions for a tax year must be made before the tax filing deadline.

The Advantages of a Roth IRA

Contributions can be made after age 70 ½ (unlike a traditional IRA)

Eligible individuals may contribute up to a specified annual limit

Contribution eligibility is permitted with active participation in an employer’s retirement plan

Tax-free withdrawals after age 59 ½ are permitted once an account has been established for 5 years

No required minimum withdrawals when you reach age 70 ½ Heirs do not pay taxes on earnings

The Disadvantages of a Roth IRA

Early withdrawals above contributions are fully taxable and subject to a 10% penalty

Contributions limits typically change each year for every individual Tax rules are subject to change

Money must remain in the account for at least 5 years

When you die, your heirs must follow the same minimum withdrawal rules as a traditional IRA

Distribution Rules
If you own several traditional IRAs, they are treated as a single account when calculating the tax consequences of distributions from any of your accounts. To be tax-free, a distribution must meet both of the following conditions:

The distribution must occur after the 5-year waiting period

The distribution must occur on or after the individual reaches age 59 ½, directed to the individuals beneficiary or estate, directed to the individual who has become disabled, or used for a first-time home purchase

Traditional and Roth IRA Contribution Limits

The maximum amount you can contribute to a traditional IRA is $6,000 for the tax year 2022 – if you are younger than age 50.

Employees 50 years and older can contribute an additional $1,000 per year as a “catch-up” contribution, to make their maximum IRA contribution of $8.000.

Only earned income from work can be contributed to an IRA, and you can’t put more into the account than you earned.

Like a traditional IRA, only earned income can be contributed to a Roth IRA.

You can contribute up to $7,000 to a Roth IRA for the tax year 2024. 

If you are 50 or older, the maximum limit is $8,000.

There are also maximum contribution limits based on your household income and filing status.

You cannot contribute at all if your earned income exceeds the maximum limit.

Spousal IRA

You may be permitted to create and contribute to an IRA for a spouse if you are employed and have a non-working spouse with little to no income. However, you must be legally married, and file a joint income tax return by the end of the tax year. Additionally, you must be employed and have an earned income equal to the amount you contribute to the IRA. If you plan to open a traditional IRA, your spouse must be younger than 70 ½. If you decide to open a Roth IRA, no age limit applies.

For the tax year 2022, you can contribute no more than $6,000 of your earnings to a spousal IRA. If your spouse is age 50 or older, you can contribute an additional $1,000 for a maximum of $7,000. You can be the beneficiary of the spousal account only if the account is established in your spouse’s name only. Even if you make contributions to the spousal account it cannot be set up as a joint account.

Education IRA

You can set up an Education IRA for your child. Money contributed to this IRA is taxed but the earnings are not if the student withdraws the money to pay for qualified education expenses.  Qualified education expenses include tuition and fees, books and supplies, and room and board.  The student is designated as the beneficiary and is permitted to make withdrawals at any time. To obtain more information check with the IRS or your financial planner.

Child IRA

Most people do not know you can create an IRA for your child or grandchild if qualified. To qualify for an IRA, the child must have earned income from a job. When setting up such an account, you teach your child the benefits of saving and investing while helping them with their retirement plans. 

Putting money into a Roth IRA for your child can provide even greater benefits. The money grows tax-deferred and can be withdrawn at retirement tax-free. Assume, a child earns $3,000 each year for five years and contributes the entire amount to a Roth IRA each year. By the time he or she reaches retirement age, the $15,000 could be worth between $700,000 and $1,500,000 depending on the rate of return and if the money is left untouched until retirement age.

If your child or grandchild is employed and you are planning on investing in an IRA, this is a great option.  However, there are a few guidelines to follow:

Maintain detailed and accurate records

Keep records of the dates, employer, and amounts paid for each job

Treat your child like all other employees while working in the family business

File the proper tax returns if self-employed

Make sure to make contributions from earned income

Always work for a legitimate employer

Distinguish between self-employment and a job.

Finding an investment company that will open an account for a minor may be difficult. But once the child reaches 18, it will be easy to open an IRA.

Bottom Line

An IRA is an excellent way to save and invest money. Whether you choose a traditional IRA, a Roth IRA, or an Education IRA, planning for your future is important. A traditional IRA is tax-deferred until you reach retirement age and will be deducted from your income. A Roth IRA contribution is after-tax dollars and you usually do not have to pay taxes on what you earned. An education IRA can provide tax-free money for your child’s education if you follow the guidelines.