Bob Brinker's Marketimer

  Monday November 20, 2017

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WHAT IS A TRADITIONAL IRA?

Before we look at deductions more closely, let's identify the traditional IRA. It may help to distinguish it from the Roth IRA. The differences lie in deductibility and taxability. For the sake of clarity, remember that all IRAs have two components: the contributions you make to them, and the earnings that grow on them.

The traditional IRA has these characteristics:

• Contributions you make may be tax-deductible.

• If your contributions are deductible, you will be taxed on them when you make withdrawals.

• The dividends and capital gains that build on your contributions will not be taxed until you make withdrawals.

The Roth IRA has these characteristics:

• Contributions you make are never tax-deductible.

• You will not be taxed on your contributions when you withdraw them.

• The dividends and capital gains that build on your contributions will not be taxed at all, if you begin making withdrawals after age 59½ and you have waited at least five years to do so.

The largest contribution allowable to either plan for 2005-2007 is the smaller of $4,000 or 100 percent of earned income from employment. Individuals must have earned income in order to contribute to IRAs.  For 2008 and beyond, the IRA contribution limit will reach $5,000. One must not exceed the maximum contribution amount for all traditional and Roth IRA accounts combined. The law also allows taxpayers age 50 and above to make an extra, "catch-up" contribution of $500 each year until 2005. For 2006 and later, the "catch-up" contribution will increase to $1,000. So, for example, when the regular contribution limit reaches its $5,000 peak in 2008, the over-50 taxpayer is scheduled to have a $6,000 annual IRA contribution limit.

Investors who want to use an IRA to reduce their taxes may find the traditional IRA suitable for them.




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