The University of Alabama

UA Matters: Basic Guidelines for Retirement Planning

Dr. Shane Stinson

Dr. Shane Stinson

While calendar year 2013 is already behind us, the April 15 deadline to file personal income tax returns marks the final day to make qualifying 2013 contributions to an individual retirement account, or IRA. This can be a good time to consider your tax situation while planning for your future.

The University of Alabama’s Dr. Shane Stinson offers some basic guidelines when considering two popular retirement planning options: traditional and Roth IRAs. These and other useful retirement planning tips are available in IRS Publication 590.

Traditional IRAs generally allow taxpayers to defer taxes on investment income until they reach retirement age. This feature is especially attractive to taxpayers who expect to fall into a lower marginal tax bracket when they retire. Depending on a taxpayer’s marital status and adjusted gross income, or AGI, a traditional IRA can also provide current tax savings in the form of deductions.

When can I contribute to a traditional IRA? Qualifying contributions for a given year can be made up to the original due date of the annual personal income tax return, generally April 15 of the following calendar year. Contributions can be made for each year that a taxpayer receives compensation (including wages, commissions, self-employment income, alimony, and/or nontaxable combat pay) and has not reached age 70½.

How much can I contribute to a traditional IRA? Total combined contributions to traditional and Roth IRAs are generally limited to the lesser of $5,500 per taxpayer ($6,500 for ages 50 and above) or earned income. Further restrictions may apply to the lesser earning spouse of a married filing jointly couple.

How much can I deduct on my tax return? When the taxpayer is covered by a retirement plan at work, single and head of household filers whose modified AGI is $59,000 or less may fully deduct traditional IRA contributions. This deduction is gradually reduced for modified AGI over $59,000 and is completely eliminated at $69,000. For married, filing jointly and qualifying widow(er) filers, the deduction is gradually reduced for modified AGI over $95,000 and is completely eliminated at $115,000.

Deductions for married, filing separate filers are eliminated when modified AGI exceeds $10,000. Separate and more relaxed AGI thresholds apply when the taxpayer is not covered by a retirement plan at work. Traditional IRA contributions are for AGI deduction, which may improve a taxpayer’s chances of qualifying for subsequent deductions and credits whose amounts are limited on the basis of AGI. In addition, certain low-income taxpayers may qualify for a nonrefundable saver’s credit by filing Form 8880 with their annual income tax return.

What happens when I draw funds from my account? If distributions are taken after the taxpayer reaches age 59½, the proceeds are generally taxed as ordinary income. Distributions taken before age 59½ may be subject to an additional 10 percent penalty for early withdrawal. To the extent any prior contributions were deemed nondeductible on the basis of AGI, an allocated portion of the distribution is considered nontaxable to the recipient.

Roth IRAs offer similar investment opportunities to traditional IRAs, but differ in their tax treatment. Unlike traditional IRAs, Roth IRA contributions are not deductible for tax purposes. However, qualifying distributions of accumulated earnings from a Roth IRA are not taxable. This makes Roth IRAs particularly attractive to taxpayers whose marginal tax rates are expected to increase over time.

When can I contribute to a Roth IRA? As with a traditional IRA, qualifying contributions for a given year can be made up to the original due date of the annual personal income tax return, generally April 15 of the following calendar year. Unlike a traditional IRA, however, there is no age limit for contributions to a Roth IRA.

How much can I contribute to a Roth IRA? As mentioned above, total combined contributions to traditional and Roth IRAs are generally limited to the lesser of $5,500 per taxpayer ($6,500 for ages 50 and above) or earned income. Unlike a traditional IRA, Roth IRA contributions are limited on the basis of AGI. For single and head of household filers, the maximum allowable contribution to a Roth IRA is gradually reduced once modified AGI exceeds $112,000 and is completely eliminated at $127,000.

For married, filing jointly or qualifying widow(er) filers, phase-out of the maximum allowable Roth IRA contribution begins when modified AGI exceeds $178,000 and ends at $188,000. Roth IRA contributions for married, filing separate filers are eliminated when modified AGI exceeds $10,000 if the taxpayer lived with his/her spouse at any time during the year. Otherwise, a married, filing separate taxpayer is subject to the same contribution limitations as a single filer.

How much can I deduct on my tax return? Contributions to a Roth IRA are not deductible. However, certain low-income taxpayers may qualify for a nonrefundable saver’s credit by filing Form 8880 with their annual income tax return.

What happens when I draw funds from my account? Taxpayers can withdraw contributed funds from a Roth IRA at any time without penalty. Similarly, qualifying distributions of accumulated earnings from a Roth IRA are not taxable. A qualifying distribution is generally made after a Roth IRA account has been open for five years and the taxpayer has reached age 59½. Nonqualifying distributions of accumulated earnings from a Roth IRA are subject to ordinary income taxes and a 10 percent penalty.

Stinson is an assistant professor of accounting in UA’s Culverhouse School of Accountancy.uamatters_logo-thumb

 

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