You need to compare IRA-based retirement plans.
In 2011, a person under 50 years of age can not contribute in any single year more than $16,500 (or their total annual compensation if it is less than this amount) to an employer-sponsored savings plan. If they are 50 years or older, the maximum contribution (as part of the catch-up provision) increases to $22,000. If they also are fortunate enough to receive employer-matching funds, the maximum contribution limit regardless of age and including matching funds cannot exceed $49,000.
Most people need to create their own IRA-based “personal” pension plan.
Few working people today have the opportunity or good fortune to participate in sponsored-retirement plans; even fewer maximize their personal contribution to receive an employer’s matching contributions. Thus, people are left to their own financial devices to somehow save for their future. The two common personal “pension-plans” available to the majority of people who do not own their own business and do not have the opportunity to participate in an employer-sponsored plan are the traditional IRA and the Roth IRA.
What are IRA-based savings plans?
Either traditional IRA or Roth IRA
Traditional and Roth IRA plans are specially designated savings accounts designated for a long-term distribution such as, for example, when a person decides to retire. These plans are commonly known as defined-contribution savings plans. In most cases, the distribution phase for these funds will occur when the taxpayer has retired and no longer receives regular flows of earned compensation. Since a person, no longer has regular wages, they will no longer pay high marginal levels of tax on their earned income. This single fact, what a person’s marginal income tax rate will be when funds are distributed, is the fundamental basis for deciding which kind of IRA is best for a personal long-term financial plan.
What are some differences between a traditional and Roth IRA?
Traditional IRAs are designed so that you can defer income tax until a future time when (theoretically) your marginal income tax rate will be lower than your current rate at the time of contribution. Thus, you can often deduct up to the total amount of your traditional IRA contribution from reported income in the current year on your tax return. Roth IRAs use money that has already been taxed, that is, “after-tax” money. A Roth IRA contribution is thus, not deductible. Not all people qualify for the advantages of tax deferment because of their active participation in an employer-sponsored plan and an income limit based on a modified calculation of their Adjusted Gross Income explained below.
How do you define an IRA-based contributions?
Contributions are determined the same way for any IRA savings plan. In order to save money in either a traditional or Roth IRA, you must have wages, tips, bonuses, alimony (or separate maintenance payments but not child-support) or some net self-employment income. Interest, dividends, or, for example, income for a rental house do not qualify because they are considered unearned (passive) sources of income. You cannot include foreign-earned income or foreign housing allowances either. In fact, these specially designated sources of income are what modifies your AGI (referred to above); they, along with other income adjustments, are added back into the Modified AGI (commonly called MAGI) when calculating IRA deductibility and maximum contributions limits.
What are the IRA-based contribution requirements?
Both traditional and Roth IRA contributions must be made by the due date of the personal income tax return. This due date is typically in April. Contributions do not have to be made by December 31 of the current tax year. If you request an income tax return extension, the IRA contribution due date is still the deadline for the tax year; the extension to the date does not matter. If you make an IRA contribution after the end of the tax year but before the tax return deadline, make certain you specify in what tax year the IRA contribution applies.
How do contribution limits a traditional and Roth IRA compare?
You can contribute up to a maximum of $6,000 per person (if you are over age 50, $5,000 if not) or your maximum amount of earned compensation; whichever is less. Remember the contribution limit allowed for tax year is the total amount for all IRAs reported on the tax return. The contribution limits are correspondingly higher if you are Married Filing Jointly because the income is “jointly” reported. Roth IRA contribution rules are more strictly defined compared to rules for a traditional IRA. Participation in an employer-sponsored plan does not matter but there is a MAGI phase-out threshold that restricts Roth IRA contributions in a tax year . The contribution limit does not apply to individual savings plans (for example, each separate traditional IRA or each Roth IRA).
How do distributions between a traditional and Roth IRA compare?
When you allocate funds into a savings plan, you make a contribution. When you draw down or take money from a savings plan, you make a distribution. Qualified distributions from a traditional IRA are typically considered taxable income; they were contributions made with “pre-tax” money. Roth IRA plans are funds allocated from “after-tax” money; a qualified Roth IRA distribution is not typically considered taxable income. Since part of the tax-favored treatment of any IRA fund is based on retirement objectives; money must remain in these specially designated accounts for a pre-defined period of time. If any funds are withdrawn from a qualified pension plan (this includes personal IRA accounts) prematurely (that is, ahead of some predefined time) the “early” distribution will not be considered qualified and the funds will be subject to a 10% early distribution penalty. There are some special exceptions to this rule. Another difference between a traditional IRA and a Roth IRA is an age limit. Unlike a Roth IRA, you cannot contribute to a traditional IRA in the tax year you reach 70 1/2 years of age. In fact, a required minimum distribution (RMD) of traditional IRA funds must begin at this age. A Roth IRA does not have this age restriction nor a RMD.