Retirement plans benefit from special tax advantages but also are subject to special restrictions. For instance, there are rules that allow tax breaks for contributing to retirement plans and rules that allow retirement plan income to grow on a tax-deferred basis, but there also are rules that limit annual contributions and rules that dictate the timing and amount of distributions you take from those plans.

IRAs: Considered to be the most widely used retirement plans around, IRAs are a mix of easy setup and maintenance. Anyone can open an IRA, regardless of employer approval, and you can contribute as much as you want (as long as you don’t surpass the annual limits). Listed below are the descriptions of the three most popular types of IRAs.

Traditional IRA. With this type of IRA you are able to let your assets grow on a tax-deferred basis. This is advantageous because you will not have to pay taxes on your assets until you withdraw funds from your account.

The amount that you can contribute is dependent on statutory limits, your age, and your earned income. The maximum you can contribute is equal to your earned income. Earned income is income from wages and self-employment. Investment income is not considered earned income. There is also a catch-up provision for those that are 50 years old or older. This provision allows you to make larger contributions than normal. Additionally, your spouse can use some of your income to contribute to his or her account. However, if you have reached age 70 at the end of the year of your contribution then you are no longer allowed to make contributions.

Considering other options besides the traditional IRA may be in your best interest.

Contribution deductibility is one factor that often times leads an indication to switch the type of IRA that they use. Your income level is an important indicator as to whether you will be able to deduct all of your contributions. If you and your spouse are able to participate in an employer-sponsored plan, then you will definitely be able to deduct your contributions. However, these deductions might not be worth anything if your adjusted gross income (AGI) is too high.

If you are not able to make a deductible contribution (or a Roth contribution), then you may choose to make a nondeductible contribution. Making a nondeductible contribution will still afford you the advantage of tax-deferred growth. Also, if you withdraw funds after you reach age 59 1/2, only earning will be taxed. You are able to withdraw all nondeductible contributions free of tax.

Roth IRA. You are able to contribute the same amount to a Roth IRA as you are able to contribute to a traditional IRA. The real difference between the two is their eligibility rules, such as the lack of an age limit with respect to contributions. This disregard for the age limit is only applicable if you meet the earned income requirement.

The total amount of your annual contribution to IRAs can never be larger than the defined limit. That being said, if you are eligible you can contribute all of your income to a traditional or all of your income to a Roth IRA. You are even allowed to split your contribution between the two different IRA?s.

The Roth IRA also differs from a traditional IRA in that you won’t be able to claim a deduction for your contributions. But all Roth IRA earnings can be withdrawn tax free after age 591/2, provided you’ve had the account for at least five years. (You can withdraw amounts up to your total contributions tax free at any time.)

Traditional IRAs also have required minimum distribution rules that must be followed, Roth IRAs do not have such restrictions.

If you already have a traditional IRA you may be able to convert a portion, or even all, of your traditional IRA to a Roth IRA. You will have to do a cost-benefit analysis to see if the benefit from the conversion will outweigh the added tax obligations that result from changing the plan.

Simplified Employee Pension (SEP) IRA. A SEP IRA provides self-employed individuals a way to make more significant retirement contributions than would be available to them through a traditional or Roth IRA. Funds are treated, for tax purposes, the same as IRA funds; you may claim a deduction for your contributions, and distributions will be taxed. But the contribution limits can be much higher.

This data is distributed for informational purposes only; Doeren Mayhew is not rendering legal, accounting, or other professional advice or opinions and assumes no legal responsibility. Contact Doeren Mayhew for more information.

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