Effect of Individual Retirement Arrangements (IRAs) on Your Taxes


 

How would it affect my taxes? Would I be able to make deductions?  The answer depends on which type of IRA you decide to go with at the end.  That really is one of the most important consideration you need to have before deciding on which one to settle for.  The tax effects on each type are as detailed below.


Traditional IRA
  • You can deduct all or your IRA contribution if you’re single and your AGI is below $53,000. If your income is between $53,000 and $63,000, you can deduct a gradually decreasing portion of your contribution. You cannot deduct anything is your AGI is over $63,000.
  • If you fall within the twenty-five percent marginal tax bracket, and contribute $4000, you may receive a $1000 deduction from your tax liabilities.
  • If you were a participant in your employer's pension/profit sharing plan, your traditional IRA contributions would not be fully deductible. If you were not in your employer's pension/profit sharing plan, your contributions would be fully deductible.
  • Withdrawals from the account are taxed like income and early withdrawals are subject to an additional penalty of 10%. There are exceptions for withdrawals used toward education, medicals costs above 7.5% of your gross annual income, first home purchases, health insurance, disability, and death.

Roth IRA

Contributions are made with after-tax income. Growth within the Roth IRA and withdrawals from the account are not taxed. Contributions are not tax-deductible.


Simple IRA

Growth within the account is subject to taxation. Withdrawals from the account are also subject to taxation, and early withdrawals (withdrawals before you reach age 59) are subject to a 25% tax.


Simplified Employee Pension (SEP) IRA
  • Contributions do not have to be made every year. Contributions are not taxable and not included in gross income
  • Growth within the account is taxed like income. Withdrawals are subject to taxation and are subject to the same withdrawal rules as the traditional IRA. There is a penalty for early withdrawal (withdrawals before you reach age 59).

What are the regulations regarding inherited IRAs?
  • For a traditional IRA, the value of the IRA will be included in your estate. However, the traditional IRA earnings will also be taxed as income to your beneficiaries. This could cause a very large combined estate/income tax to be assessed against your traditional IRA.
  • With a Roth IRA, you are able to build up the value of the IRA free from all income taxes for the benefit of your heirs. And while estate taxes may have to be paid on the value of the Roth IRA upon your death, no part of the Roth IRA will be subject to income tax to your beneficiaries.
  • If the beneficiary of your Roth IRA is your spouse, he/she can treat the Roth IRA as his/her own.
  • If the beneficiary of your Roth IRA is someone other than your spouse, Roth IRA distributions need to be made:
    1. By the end of the year containing the fifth anniversary of the account owner's death; or
    2. Over the life expectancy of the beneficiary, starting no later than Dec. 31 of the year following the year that the account owner died.