The Basics of a Traditional IRA

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The good old fashioned Traditional IRA. With so much talk about IRAs these days, it’s hard to keep track of what each one does.  For those who qualify, the Traditional IRA offers one of the few deductions you can still take advantage of to lower your 2006 taxes.

What is a Traditional IRA?

An IRA is a personal savings account that allows you to accumulate money tax free (deferred) until you retire. What makes a Traditional IRA different from other IRAs (like Roth IRAs) is that you can also deduct the amount you contribute to your IRA from your income. But that up-front advantage comes at a price. Unlike Roth IRAs, you need to pay taxes on the earnings you’ve made over time when you start to withdraw your funds in retirement.

How much can I contribute to an IRA account each year?

For 2007, each individual can contribute up to $4,000 provided your “earned income” is greater than that.  If you’re age 50 or older, it’s the lesser of $5,000 or your “earned income.” Note: if you’re 70 ½ by the end of the tax year, you can no longer contribute to your IRA.

What’s earned income?

It’s money that you earn from working such as wages, salary, bonuses, and self-employment income. Taxable alimony is also included. It doesn’t include earnings from investments (like interest, dividends, and rental properties), pensions, and social security. Check out the IRS Publication 590 for more details.

Can my spouse contribute to an IRA if he/she doesn’t have “earned income?”

Yes! If only one spouse has earned income, you both can make IRA contributions.  The combined limit for the two of you is the lesser of $8,000 ($4,000 for each of you) or your combined earned income for the year.  The limit is increased by $1,000 for each spouse who is age 50 or older by the end of the tax year. 

Do I get a tax deduction for my Traditional IRA contribution?

If you don’t have access to an employer-sponsored pension plan (like a 401(k)), then yes you get a deduction for your IRA contribution. 

If you do have access to an employee retirement plan, it gets more complicated. If you’re an active participant in your employer retirement plan and your filing status is single or head of household, you get a deduction as long as your modified AGI (Form 1040, line 37, adjusted gross income) is less than $52,000. You’ll get a reduced deduction if your modified AGI is between $52,000 and $62,000 and no deduction if that AGI is more than $62,000.

If you and your spouse are filing married filing jointly, it’s even more complicated. 

If both have a retirement plan with your employers, you can still deduct the contribution if your AGI is less than $83,000. If your AGI is between $83,000 and $103,000 you can take a reduced deduction. If that AGI is over $103,000 you can contribute but can’t deduct it. If only one of you is covered by an employer plan, the phase out is between AGI of $156,000 and $166,000. A tad complicated, isn’t it?

How can I figure out my deduction?

Fortunately, TurboTax can figure out this deduction for you. You just need to answer all the questions in TurboTax and it will figure out the allowable IRA deduction.

When can I make an IRA contribution for 2007?

Here’s the great part. Contributions can be made to your IRA anytime during the tax year and until the April due date of the return for that year. So contributions for 2007 can still be made until April 15, 2008. If you make the contribution between January and April, be sure to designate which year the contribution is for.

For additional information on IRAs:

IRS Tax Topic 451

IRS Publication 590

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