The Rules and Limits of Traditional IRAs

When looking at all of the different investment and retirement planning tools available, its easy to become overwhelmed. However, the Individual Retirement Account (IRA) is one of the most popular and widely use retirement accounts.

The rules that govern the application and management of IRAs change slightly from year to year. This is due to the changes Congress makes in tax laws (the following figures are for 2012).

Traditional IRA Eligibility Rules

To be eligible to invest in an IRA, you only need to have earned income for the year in the amount of the contribution. This includes both self-employment and part-time income as well. As with many tax advantaged accounts, there are restrictions to investing in an IRA which include the participation in a tax-qualified retirement plan and if your income is above certain thresholds.

If you are eligible or participate in a company sponsored retirement plan, the tax advantages of Traditional IRAs are limited. The tax deductions of investments in Traditional IRAs are phased out for single filers that make adjusted gross income (AGI) between $58,000 and $68,000. In addition, married couple’s IRA tax deductions are phased out between AGI of $92,000 and $112,000.

Traditional IRA Contribution Limits

Depending on your contribution eligibility, individuals will be able to contribute up to $5,000 per year up to age 49 and $6,000 if you are 50 or older. The additional $1,000 for individuals over 50 years of age is referred to as a “catch up” contribution. Lastly, you will not be able to contribute to an IRA past the age of 70 1/2 years old.

If you are not eligible for the tax deductions of a Traditional IRA, you will still be able to contribute. The advantage of contributing to a non-tax deferred IRA is that your earnings (through investments) will not be taxed until you make a withdraw. This avoids the short and long-term capital gains tax of your Traditional IRA investments. This can grow to be a significant amount over long time periods.

Traditional IRA Income Distribution

During retirement, Traditional IRA distributions can provide a decent source of income. However, due to the tax advantages provided for this retirement account there are some restrictions concerning when you can withdraw your cash.

Traditional IRA holders can begin to withdraw from their account without penalty at the age of 59 1/2. If a withdraw is needed before this time, your account might incur a 10% penalty. However an account is exempt from these penalties in cases of permanent disability or death. Account holders over the age of 70 1/2 must begin to take the minimum distribution.

Traditional IRAs are a good investment and should be included in most retirement and financial plans. The tax deductions and tax avoidance is worth the hassle of opening a new investment account.