Friday, August 8, 2008

1040 FYI: IRA BASICS

Part I – Traditional IRA

Contributions to a “traditional” IRA are either deductible or non-deductible. If you are an active participant in an employer-sponsored pension plan, such as a 401(k), a 403(b) or a SEP, the amount of your traditional IRA contribution that is deductible is phased-out for a “modified” Adjusted Gross Income (MAGI) for tax year 2008 of $53,000 to $63,000 if filing as Single or Head of Household, or $85,000 to $105,000 if married and filing a joint return.

“Modified” AGI in this case begins with “regular” AGI and adds back the-

· foreign income and housing exclusions
· savings bond interest exclusion for higher education costs
· adoption assistance benefits exclusion
· deduction for student loan interest
· deduction for qualified tuition and fees
· deduction for domestic production activities

Deductible contributions are made with “pre-tax” dollars. If all of your contributions to all of your IRA accounts over the years were fully deductible, then all IRA distributions are fully taxable. Amounts that were “rolled-over” to an IRA from a pre-tax employer plan like a 401(k) are treated as deductible contributions.

Non-deductible contributions are made with “after-tax” dollars. You have already paid income tax on these contributions. Accumulated non-deductible contributions make up your “basis” in the IRA. If some of your IRA contributions over the years were non-deductible, then a portion of any IRA distribution is a tax-free return of your after-tax contributions. The tax-free portion is determined by a special formula and is calculated on IRS Form 8606.

Many taxpayers have more then one IRA account, and each individual account may have a different mix of deductible and non-deductible contributions. However, when you calculate the tax-free portion of a traditional IRA distribution all monies in all traditional IRA accounts are lumped together.

You must begin to take annual minimum distributions from your traditional IRA once you reach age 70½. Once you turn age 70½ you can no longer make contributions to a traditional IRA, even if you continue to work and have earned income. Upon your death your beneficiaries will be taxed on withdrawals from an inherited traditional IRA.

Part II – ROTH IRA

You can contribute to a ROTH IRA for 2008 if your “modified” AGI (same as above) is under 116,000 if Single or Head of Household, or $169,000.00 if Married Filing Joint.

Contributions to a ROTH IRA are made with “after-tax” dollars. ROTH IRA contributions are never deductible. Qualified distributions from a ROTH IRA are totally tax free.

A qualified distribution is one that is made after a 5-year holding period, beginning on the first day of the first year you make a contribution, and is made after the taxpayer reaches age 59½, or due to death or disability or for a qualified “first-time” home purchase. The earnings portion of a non-qualified distribution is fully taxable and may also be subject to a 10% penalty.

You do not have to begin taking annual minimum distributions from a ROTH IRA when you reach age 70½. You never have to touch the money in a ROTH IRA during your lifetime. You can continue to make contributions to a ROTH IRA after you turn age 70½ as long as you have earned income. If you are still working at age 80 you can contribute to a ROTH IRA. Beneficiaries do not have to pay income tax on distributions from an inherited ROTH IRA.

TTFN

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