In recent years, IRAs have become the single largest vehicle for retirement savings in the United States. At the end of 2007, IRAs held $4.8 trillion in retirement savings, whereas employer-sponsored defined-contribution plans like the 401(k) held $3.5 trillion and defined-benefit plans (traditional pensions) held $2.3 trillion.1
As a retirement savings vehicle, the IRA has become more attractive with age. When IRAs were created in 1974, the annual contribution limit was $1,500. In 2009, workers can contribute up to $5,000 to all IRAs combined, and those 50 and older can contribute an additional $1,000 in catch-up contributions.
Contributing the maximum amount to either a traditional or a Roth IRA is a positive step to help accumulate the funds you will need for retirement. Furthermore, there are tax benefits you can appreciate both now and later.
Anyone with earned income is eligible to contribute to an IRA. Contributions to a traditional IRA are generally tax deductible. However, if a worker also participates in an employer-sponsored retirement plan, the tax deductibility of the contributions may be eliminated or phased out, depending on adjusted gross income.
IRA assets accumulate tax deferred. Traditional IRA withdrawals are subject to ordinary income tax, and distributions taken prior to age 59½ are subject to a 10% federal income tax penalty.
Another Option
A Roth IRA offers the opportunity for both tax-deferred growth potential and tax-free retirement income. The contribution limit is the same as a traditional IRA, but Roth contributions are not tax deductible. The major difference with a Roth IRA is that qualified withdrawals are tax-free.
To participate in a Roth, workers cannot exceed certain income thresholds. Individual filers with modified adjusted gross incomes (AGIs) under $105,000 and married couples (filing jointly) with AGIs under $166,000 are eligible to make the maximum Roth contribution in 2009.2 To qualify for a tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59½ or as a result of death, disability, or a first-time home purchase ($10,000 lifetime maximum).
Understanding the rules and features associated with both types of IRAs may help you determine which might benefit you the most. Whether you decide on tax deductions now or tax-free income later (or both), an IRA could help you reach your retirement savings goals.