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The ABCs of our IRAs

By GREGORY GAY
Published June 27, 2006

There are two commonly used individual retirement accounts (IRAs): the traditional IRA and the Roth IRA.

The financial advantages of a traditional IRA are that contributions may be deducted from income taxes and that contributions and earnings are not taxed until distributed.

By contrast, contributions to a Roth IRA are not deductible. However, contributions and earnings may not be subject to income tax when distributed.

A taxpayer younger than 70 can annually deduct from income taxes the lesser: 100 percent of earned income or $4,000 contributed to a traditional IRA.

A taxpayer who is 50 or older by the end of the calendar year can also deduct an additional $1,000 of earned income that is contributed to a traditional IRA. This permits older people to catch up for earlier years when they could not make a retirement contribution.

Earned income means wages or other compensation for personal services. Gains from the sale of property, rental income, interest or dividends or Social Security payments are not considered earned income. If a joint income tax return is filed, a contribution to an IRA can be made for a spouse without earned income.

The rules for deducting contributions to a traditional IRA change if the taxpayer is a member of a pension plan:

A single person actively participating in a retirement plan may still make a completely deductible contribution to a traditional IRA if his income does not exceed $50,000. He may partially deduct contributions to a traditional IRA if his income is between $50,000 and $60,000. He may not deduct any contribution to a traditional IRA if his income exceeds $60,000.

A married taxpayer who is an active participant in a retirement plan or whose spouse is an active participant in a pension plan may still make a completely deductible contribution to a traditional IRA if the couple's income does not exceed $75,000. Married taxpayers may partially deduct contributions to a traditional IRA if their income is between $75,000 and $85,000. They may not deduct any contribution to a traditional IRA if their income exceeds $85,000.

The contributions to a traditional IRA and the resulting earnings must be paid out in at least minimum annual distributions no later than April 1 after the taxpayer reaches age 70½. There will be an income tax on these distributions.

By contrast, a Roth IRA can be established by a single person who does not have annual income exceeding $110,000 or married taxpayers with annual income of $160,000 or less.

A Roth IRA permits a person to make nondeductible annual contributions up to the same limits allowed for a traditional IRA, regardless of a person's age. There is no tax on the income withdrawn from a Roth IRA if the contribution was in that IRA at least 5 years and the taxpayer is at least 59½ when the withdrawal occurs.

But, with a few exceptions, there is a 10 percent penalty on the income withdrawn from a Roth IRA before age 59½. However, at age 70½ no mandatory withdrawals are required.

A person who participates in a pension plan and earns more than the income limit for establishing either IRA can still contribute earned income to a nondeductible IRA, up to an amount that would otherwise be deductible.

Until now, there was little income tax benefit in contributing to a nondeductible IRA, because the income earned was subject to taxation when withdrawn. In addition, withdrawals have to begin at age 70¹/_2.

However, the recently passed Tax Increase Prevention and Reconciliation Act of 2005 states that for tax years beginning after Dec. 31, 2009, the income cap that prohibited a person's earning more than $100,000 from converting a traditional IRA to a Roth IRA will be removed.

There are several rules about taxes on such IRA conversions, including changes in the taxes adjusted over different years. For detailed advice, consult a certified public accountant or tax attorney.

--Gregory G. Gay is a lawyer who specializes in elder law in Pasco, Hernando and Citrus counties. Write him in care of Seniority, St. Petersburg Times, P.O. Box 1121, St. Petersburg, FL 33731.

[Last modified June 27, 2006, 07:01:16]