IRAs: Maximizing Tax Deductions With Proper Planning

What is an IRA?

An IRA (Individual Retirement Account) is a trust or custodial account with which the taxpayer directs income toward investments that can grow tax-deferred. There are various kinds of IRAs, including the traditional IRA, the Roth IRA, SIMPLE IRA and SEP IRA. Contributions to the traditional IRA may be tax-deductible depending upon the taxpayer’s income, tax-filing status and other factors. Withdrawals from the IRA at retirement are taxed as income.

What is a Roth IRA?

The Roth IRA is named after Sen. William V. Roth Jr. It was introduced as part of the Taxpayer Relief Act of 1997. It is structured so that the assets in the Roth IRA become after-tax assets, which may create tax-free retirement income for you and maybe for your beneficiaries. All transactions within the IRA have no tax impact, and withdrawals are usually tax-free.

What are the guidelines for IRA contributions?

An IRA can only be funded with cash or cash equivalents. It is prohibited to attempt to transfer any other type of asset into the IRA. Doing so will disqualify the taxpayer from any beneficial tax treatment. Rollovers, transfers and conversions between IRAs and other retirement arrangements can include any asset.

Are there limits for IRA contributions?

IRA contribution tax deductions are based upon your income and your eligibility to participate in a workplace retirement plan. Your total contributions to either a traditional IRA or Roth IRA cannot exceed the lesser of your earned income for the year and the annual maximum amount. The maximum IRA contribution limit varies by year.

For 2016, the maximum for an IRA contribution was $5,500 for those under age 50, and $6,500 for those over age 50. Now, in the year 2017, the limits for IRA contributions are the same.

You also must be under age 70 1/2 to contribute to a traditional IRA. (Roth IRAs, by contrast, have no age restrictions.)

How do I calculate my earned income requirements?

Only people who have earned income can contribute to an IRA. Earned income consists of wages as reported on a W-2, tips, self-employment income from a business or farm, and alimony. Other taxable but unearned income, such as dividends and interest income, do not count toward this eligibility requirement.

When is the deadline for contributing to my IRA?

The cut-off date for contributing to a traditional IRA and potentially receiving a tax deduction is not until the filing deadline of your tax return. Typically, that means you have until April 15 of the year following the year in which you will receive a tax deduction. Contributions to IRAs can be considered retroactive to the previous tax year.

Where do I claim my tax deduction?

You can report your tax-deductible IRA contribution directly on Form 1040 or Form 1040A. You don’t need to itemize to report this deduction.

My funds are currently in my employer’s 401(k) plan. Will it cost me to transfer funds to my IRA?

With a direct rollover from an employer-sponsored plan to your IRA, the distribution check is payable directly to your new trustee or custodian. This will help you to avoid mandatory tax withholding.

When can I withdraw funds from my IRA?

Although money can be distributed from an IRA at any time, there may be penalties for withdrawing funds under certain circumstances. Once the owner reaches age 59 1/2, the money can typically be withdrawn from the IRA penalty-free as taxable income.

Traditional IRA owners must begin taking distributions of at least the calculated minimum amounts by April 1 of the year after reaching age 70 1/2, or they will incur penalties.