Roth IRA eligibility
Roth IRA accounts have annual maximum contributions. For 2014, the maximum is $5,500 for everyone except those aged fifty or older who can contribute up to $6,500. Both traditional and Roth IRAs limit contributions to not more than the amount of annual earnings. The Roth IRA has a means test; one must have an income, but one cannot earn more than a certain amount. The Roth IRA formula to determine eligibility called the MAGI or modified adjusted gross income. Those who exceed the limits for married joint filers or single filers begin what is called a phase-out. Eligible single tax filers with MAGI’s of less than $129,000 are eligible, and the phase-out begins at $114,000. Married joint filers with MAGI’s of less than $191,000 are eligible although the phase-out begins at $181,000. In this application of rules, one loses more and more of the allowed contribution amount as income exceeds the threshold up to a point where no contributions are allowed.
Traditional IRA Eligibility
Anyone with earned income can start a traditional IRA. The same annual limit applies as in a Roth plan, $5,500 per year for 2014 and 2015. Traditional IRA’s have no such MAGI limits, and eligibility is broader than Roth plans. For both types, one can make contributions for the year up to the tax filing deadline or April 15, of the following calendar year. Account holders can make no further contribution after age 70. Roth Account holders can continue contributions throughout their lifetimes.
Roth Taxes and Penalties
The outstanding feature of a Roth IRA is that the federal government does not tax earnings on the contributions. The Roth IRA provides tax-free income by withdrawals after age 59, if, the funds have been in the account for more than five years. Contributions are taxable, and there are no deductions for amounts contributed to a Roth IRA. Account holders can withdraw contributions at any time without penalty. The federal government taxes early withdrawal of IRA earnings and applies a ten percent penalty. There are some specific exceptions to the Roth penalty tax due to circumstances such as buying a first home.
Traditional IRA Taxes and Penalties
Traditional IRA’s permit tax deductions for the amounts invested; however, all withdrawals are taxable at the rates that apply to individual tax brackets. Thus, there is no tax-free income stream with traditional IRA’s. However, those with both Roth and traditional IRA’s can benefit from a lower effective tax rate on their combined IRA income. IRA deductions are limited when the saver and or spouse are covered by an employer-sponsored IRA plan. There is a penalty on early withdrawal of contributions and earnings from a traditional plan, and taxation on contributions and earnings after retirement. The tax deductions for IRA contributions can lower taxpayers adjusted gross income and improve eligibility for other tax considerations. The law provides an exception to tax penalties for early withdrawal to permit up to $10,000 for first-time home buyer expenses.
Roth IRAs have no Required Minimum Distributions or RMDs, during the account holder’s lifetime. Traditional IRA’s differ from Roth IRA in this important way; traditional accounts require withdrawals after age 70. Traditional retirement account holders must take the first RMD by April 1 of the year following the year in which they reach age 70½. Roth account holders can continue to grow wealth by contributing past age 70.
Roth funds left in the arrangement after the holder’s death pass on to heir’s tax-free. IRA proceeds can pass through the decedent’s estate, but the government will tax it as income to heirs. Thus, Roth IRA’s offer an excellent way to pass the benefit to one’s heirs. The Roth advantage avoids further taxation in accumulating the wealth and in distributing it during and after life.