IRAs or Individual Retirement Accounts are generally savings plans that have many restrictions. In fact, a key benefit of an IRA is that it postpones paying taxes on both earnings and savings growth until you withdraw the money. IRAs are of 3 types and each have their respective eligibility needs and tax implications.
1) Traditional IRA: its key features are as follows:
• You will receive a tax deduction on the savings you contribute to the account. It is this reduction that will reduce your taxable income, which means you won’t pay income taxes, especially on the amount you set aside separately in the traditional IRA.
• Your savings will grow but with deferred taxes which indicates that you will not be required to include capital gains, dividends or interest from Individual Retirement Accounts in your annual income.
• When you withdraw the cash, the distribution from the IRA will be added to the taxable income. This will be taxed as ordinary income.
• For example, if the money is withdrawn before you turn 59½, there will be an additional 10 percent tax on that earlier distribution.
• In fact, you should start withdrawing cash from a traditional IRA when you turn 70½. And you must take the required minimum distribution each year or pay a 50% excise tax on the required minimum distribution amount.
2) Non-Deductible Traditional IRA – This is a Traditional IRA. Contributions, however, are not tax deductible. Its features include,
• Savings develop tax deferred
• While you begin receiving distributions, a portion of the distribution is a tax-free return of your original nondeductible contribution, while the remainder will be taxed as ordinary income.
Typically, people choose the non-deductible IRA at a time when they are in a specific financial situation, especially when they are covered through a retirement plan through their employer, while their income is high enough to be eligible to deduct traditional IRA contributions and are not eligible to fund a Roth IRA while wanting to contribute additional retirement savings in the case of the tax-deferred account. A key difference between a traditional IRA and a non-deductible IRA is actually the tax treatment related to the original contribution. Because it is a traditional IRA, the other rules that apply to a traditional IRA also apply to nondeductible IRAs.
Roth IRA account
The Roth IRA account offers tax-free savings, as well as distributions. Unlike a traditional IRA, you won’t get any deductions for contributions here. This makes it similar to non-deductible IRAs. However, there are notable differences in the way the distribution is taxed. Below are some key features of the Roth IRA,
• The necessary minimum distribution rules do not apply to the Roth IRA.
• Has income limitations
• In fact, you can contribute to the Roth IRA despite being covered through a retirement plan
• Roth IRA distributions are absolutely tax-free as long as you meet certain conditions.
• Savings are developed within a Roth IRA without the requirement to pay any taxes on both growth and earnings.
These are the different types of IRAs. Study them thoroughly and take advantage of the benefits.
