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The Traditional IRA is a savings plan that offers certain tax advantages for
individuals to plan for retirement. Contributions made to a Traditional IRA are
made with pre-tax dollars. The plan grows tax-deferred.
Tax Treatment
The Traditional IRA has two tax advantages. First, your contributions to the
plan may be tax deductible in the year in which you contribute. Second, the
Traditional IRA grows tax-deferred, which allows for greater compounding of
interest.
However, when the time comes to take money out of a Traditional IRA, you must
pay taxes on both the principal and the gains.
Contribution Limits
For the tax year of 2006, individuals can contribute 100 percent of earned
income up to $4,000 to a Traditional IRA. In 2008, the contribution limit will
rise to $5,000 and will then be adjusted according to inflation each subsequent
year.
Individuals must be under the age of 70 ½ at the end of the tax year to be
eligible to contribute to a Traditional IRA.
Catch-Up Contribution Limits
If you are over the age of 50, you can contribute an extra $1,000, bringing to
the total contribution limit to $5,000 for a Traditional IRA.
Income Limits
There are no income limits for participation in a Traditional IRA.
Contribution Deadlines
The deadline for contributing to a Traditional IRA is the tax-filing deadline
for the year—April 15 (excluding any extensions).
Investment Choices
There are many different financial vehicles available for investment in a
Traditional IRA—including mutual funds, individual stocks and bonds, and even
options on stocks and indexes.
Early Withdrawal Options
Early withdrawals taken prior to the required age of 59 ½ are subject to
taxation and an early-withdrawal penalty of 10 percent. The IRS allows early
distributions for “hardships” that fall into these categories.
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Purchase of a primary residence
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To avoid foreclosure or eviction of a primary residence
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Medical expenses not covered by employees insurance
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Funeral expenses for parents, spouse, or dependants
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Payment of secondary education expenses
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Home repairs due to a deductible casualty loss
Distribution Requirements
Once you reach age 59 ½, they can begin to take normal distributions. It is at
this time that the withdrawals are taxed as ordinary income.
Minimum distributions are required if you are age 70 ½ and have yet to take
distributions from the account. The distribution amounts are based on IRS time
tables and other relevant factors
Rollover Restrictions
You can roll your retirement assets into either an existing Traditional IRA or
a new Traditional IRA.
You can use the Traditional IRA as a parking spot for company-sponsored
retirement accounts, such as your 401(k). For example, if you are changing jobs
and want to take your retirement assets with you, you can do so by rolling them
over into a new Traditional IRA. Rolling an existing plan into a separate
account, and keeping those funds segregated from other retirement money, will
enable you roll back into a new company-sponsored plan in the future.
Potential Penalties
The most common penalties are for early withdrawal or a failure to take a
required minimum distribution. Early withdrawal results in a 10-percent penalty
on the amount distributed along with normal taxation on the amount withdrawn as
ordinary income.
The most severe penalty that the IRS applies is upon failure to make the
required minimum distribution, which is equal to 50-percent of the amount that
should have been withdrawn.
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