IRA contributions to a traditional IRA reduce the IRA AGI or adjusted gross income because the qualifying contribution is deducted from the AGI. On the other hand, the IRA AGI for a Roth IRA is not reduced, because the contributions are funded with after-tax dollars. Any investment gain is also tax free. When the money is withdrawn at retirement, the amount is not taxed.
Therefore, the money that is deposited into a traditional IRA is deducted from the depositor's AGI, which gives the account holder a tax break on the currently funded amount. Taxes are only owed at the time of withdrawal on a traditional IRA account.
The IRS places limits on the amount you can invest annually in an IRA. For the 2018 tax year, the IRA limit for contributors is $5,500 plus a $1,000 catch-up contribution for taxpayers who are 50 years old and over. That limit increases to $6,000 for the 2019 tax year.
Holders of IRAs are not permitted to withdraw funds for retirement until they turn 59.5 years old. After the IRA holder reaches age 59.5, he or she can begin to remove funds without restrictions. After age 70.5, the IRA holder is required to take a required minimum distribution (RMD) each year, based on the balance of the IRA and the life expectancy tables published by the IRA. If the holder elects not to take his or her RMD, he or she is charged a penalty of 50% of the RMD amount.
Holders of Roth IRAs may begin to withdraw their funds after 59.5 without penalty or taxes, provided that the account has been open for five or more years. If the account was opened fewer than five years ago, the 59.5 year-old account holder will need to pay taxes on the withdrawal, but will not be subject to penalties.
You may remove contributions to your Roth IRA at any time without having to pay taxes or penalties. However, withdrawn earnings before age 59.5 are subject to a penalty of 10% plus tax, with some provisions.
For the 2018 tax year, a full deduction of an IRA investment is permitted if your AGI as a single filer is under $63,000 per year or below $101,000 annually as a joint filer. A partial deduction is allowed for single filers making $63,000 to $73,000 per year and joint filers who make more than $101,000 but less than $121,000. Deductions are not available for people making over $73,000 as a single filer or above $121,000 annually as a joint filer.
The Advisor Insight
You can elect to make deductible or non-deductible contributions to a traditional IRA. Should you choose to make deductible contributions, you can contribute up to $5,500 or $6,500 if you are over the age of 50, which will reduce your AGI by the respective amount. The deductibility is based on whether you or your spouse are covered by a retirement plan at work. If you are married and covered by an employer retirement plan then the MAGI phase-out begins at $101,000 and ends at $121,000, where you will receive no deduction. If you are single the phase-out is less.