Articles The Tax Advantage of an IRA

December 2, 2014

When you're building a nest egg for a comfortable retirement, tax advantages can give your savings a big boost. Individual retirement accounts (IRAs) offer tax breaks that can help you save. There are two main types of IRAs, Traditional and Roth, each with its own unique blend of tax benefits.

Tax-Deductible Contributions (Available With Traditional IRAs)

Benefit: You can save more by using pre-tax dollars. For example, say you're in the 25 percent tax bracket along with other single tax filers with taxable income of $37,951 to $91,900 or married taxpayers filing jointly with taxable income of $75,901 to $153,100 (for 2017). In that case, a $100 contribution effectively costs you only $75 since you don't pay tax on it. See your tax advisor for deductibility in your situation.

Tax Deferral on Account Earnings (Available With Traditional and Roth IRAs)

Benefit: Your account has the potential to grow faster than a taxable account earning the same rate of return. For example, if you're in the 25 percent tax bracket and invest $100 a month in each of two accounts—one taxable and one tax-deferred—both earning a 4 percent return, after 20 years, the tax-deferred balance will grow to $36,827 while the taxable one will reach only $27,620.1

Tax-Free Distributions (Available With a Roth IRA)

Benefit: In contrast to a Traditional IRA, from which withdrawals are taxed as ordinary income, you'll owe no tax on distributions from a Roth IRA if they're made in or after the tax year you've reached age 59½ and you've held the account for at least five years.2 That can be a big help in stretching your retirement budget.

1Rate of return is for illustration only and does not represent the return of any actual investment. Your returns will vary. Taxes will be due upon withdrawal from a Traditional IRA. Premature withdrawals (prior to age 59½) from a Traditional or Roth IRA may be subject to income tax and a 10 percent tax penalty.
2Ordinary income taxes and a 10 percent penalty apply to premature withdrawals.

A Comparison: Traditional and Roth IRAs

  Traditional IRA Roth IRA
Who can contribute? Anyone with earned income younger than 70½ or his or her spouse Anyone with earned income below the income limits or his or her spouse
Are contributions tax-deductible? You can deduct contributions if you qualify No
How much can I contribute? The smaller of 1) the annual contribution limit or 2) your taxable compensation for the year
Can I make catch-up contributions? Yes; $1,000 if you're age 50 or older (and if the contribution doesn't exceed your taxable compensation for the year)
Are withdrawals taxable? Deductible contributions and earnings are taxed as ordinary income. Withdrawals made before age 59½ may be subject to an additional 10 percent penalty unless an exception applies. Qualified distributions (generally those made after you reach age 59½ and have held the account for at least 5 years) are tax-free. Other withdrawals may be subject to ordinary income tax and a 10 percent penalty unless an exception applies.
Do I have to take required minimum distributions (RMDs)? You must begin RMDs by April 1 following the year you turn age 70½ No
When is the deadline for contributions? Your tax return filing deadline (generally April 15 for the prior tax year)

This article is intended to provide general information and shouldn't be considered tax or financial advice. Please consult a tax or financial advisor for specific guidance on tax laws and your individual financial situation.

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