Many of the posts on this blog have revolved around the Roth IRA account. With great reason, since it’s one of, if not, the best saving tool created for retirement planning. As good as opening a Roth account is, the Traditional IRA still has its place. To explain some of the rules of the Traditional IRA Account, I have solicited the expertise of JoeTaxpayer who authors the self titled blog. Here’s what Joe had to say….

For all the talk about 401(k) accounts, and Roth IRA conversions, etc, the traditional IRA (individual retirement arrangement) shouldn’t be overlooked. If you are fortunate to work at a company that offers a match on your 401(k) deposits, don’t walk away from that free money. I would suggest, however that for money beyond the match, an IRA may be the better choice.

1. Contribution Limits for 2010-2011

If you are under the age of 50, the maximum amount of money you are allowed to contribute to a Traditional IRA in 2010 is $5,000 (which is the same level as 2009). You can contribute this amount regardless of whether you are eligible to claim a deduction for using a Traditional IRA. But if you are over the age of 50, the IRS allows an additional contribution, often referred to as a “catch-up contribution,” up to $1,000. So if you already celebrated the big “5-0″, you can contribute a total of $6,000 to a Traditional IRA.

Update: The Traditional IRA Limits have remained at $5,000 and $6,000 for the 2011 tax year.

2. Traditional IRA Account Phaseout Limits

Now, let’s review the traditional IRA phaseout limits, the income levels at which you are allowed to take the deduction for an IRA. Note these limits kick in only if you have a retirement plan (401(k), 403(b), etc, but not a defined benefit plan) at work, whether or not you actually contribute to it. If you are single, the 2009 phaseout is $55,000-$65,000, for married filing joint, $89,000-$109,000. Below the lower figure in that range, you may deduct the full amount $5,000 if you are under 50, $6000 if you turned 50 in or before 2009. The amount you may deduct decreases linearly until the higher number of that range is reached. If you find you are just beyond these ranges, you’ll qualify to put money you can’t deduct into a Roth, instead of just putting after-tax money into the traditional IRA.

Editor’s note:  I’ve included a few charts that will help you with the computations.  Please note that in Chart 2 that the limits do increase.

2009 Phaseout Limits

Next, I’ll discuss the potential advantages and disadvantages of using the IRA in favor of the (non-matched) 401(k).

3. 401k vs. Traditional IRA

The 401(k) can excel in two regards. If you separate from the company at 55 or older, you can take withdrawals penalty-free. Of course, taxes are still due, but no penalty, as with an early IRA withdrawal. The 401(k) also offers the ability to borrow from the account. This can be a mixed blessing, and potentially risky move, but an option nonetheless.

IRA advantages start with low cost and flexibility. The costs within a 401(k) account are often tough to understand and often multi-layered, a potential combination of management fees as well as expenses for the underlying investment. For small plans, fees can easily run above 1.5% and even over 2%. Considering that your goal is to save money pre-tax at one rate and upon withdrawal, pay taxes at a lower rate. This advantage can disappear altogether in a decade with fees approaching 2% per year. With few limitations on what you may invest in within an IRA, you are free to choose from investments with very low expenses, many index based investments offer fees as low as .10%, a fraction of the average 401(k) expense.

A traditional IRA offers a penalty-free, but not tax-free withdrawal of up to $10,000 per person for the first time purchase of a new home. ‘New’ to the IRS just means that you didn’t own your principal residence during the prior two years, not that you never owned a home. You can also use this penalty-free withdrawal to help a child, grandchild, or parent.

A similar penalty-free withdrawal is also allowed for qualified higher education expenses for you, your children or grandchildren. Expenses include tuition, fees, room and board, books and supplies.

There is also an exception for withdrawal made to cover medical expenses exceeding 7.5% of your adjusted gross income.

If you are fortunate enough to be able to retire before age 59-1/2, you have an option called a Section 72(t) withdrawal. You are permitted to take withdrawals from your IRA that follows a “series of substantially equal periodic payments (SOSEPP)”. Once you begin this process, you must continue this exact withdrawal amount for 5 years or until age 59-1/2, whichever comes later. The choices for calculating that periodic payment are minimum distribution, amortization, and annuitization. Further details on this is available at the IRS web site.

4. Beneficiary Check

When opening up an IRA, or if you already have one, be sure to specify your beneficiaries. An IRA that doesn’t not have a designated beneficiary will become part of your estate and regardless of who inherits it, has limited options to continue its tax-deferred status. By specifying a beneficiary, and ideally a contingent beneficiary, your heir(s) can take withdrawals over their remaining lifetimes.

The IRA has been around since 1974 and with good reason, it deserves a place in your finance as the core of your long term retirement planning.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

This post is featured in the Best of Money Carnival.

Photo by Jason York Photography

2009 is quickly coming to a close and the deadline for 2010 tax returns will be here before we know it, but it’s not too late to make contributions to your traditional IRA.  Although, it’s not as attractive as the Roth IRA (in regards to tax free money), the traditional IRA still has its place for those looking to get a tax deduction and boost your retirement nest egg.  Especially those that need a tax deduction at the last minute.  The only downside with traditional IRA’s is that you don’t always get a tax deduction for making a contribution.  The rules can be complicated and it all depends on your income limits and whether you have access to another retirement plan (such as a 401k).

As a refresher, you are allowed to contribute $5,000 to a traditional IRA,  and an additional $1,000 if you are over the age of 50 with the catch up provision. If you haven’t funded one, don’t worry…..it’s not too late. You have until April 15th of next year to make the contribution for this year. That’s for all you procrastinators out there.

Rules on Getting the Tax Deduction

Step One: Determine the planned tax filing status.
Step Two: Complete this step only if the IRA holder is filing Married Filing Jointly.

Does the IRA holder or his/her spouse currently participate in an Employer-Sponsored Retirement Plan?

• If the IRA holder participates in an employer-sponsored plan and his/her spouse participates in an employer-sponsored plan and the IRA holder would like to make a deductible IRA contribution select the column “IRA Holder Participates”.
• If the IRA holder participates in an employer-sponsored plan and his/her spouse does not participate in an employer-sponsored plan and the IRA holder would like to make a deductible IRA contribution select the column “IRA holder Participates”.
• If the IRA holder does not participate in an employer-sponsored plan and his/her spouse does participate in an employer-sponsored plan and you would like to make a deductible IRA contribution select the column “Only Spouse Participates.”  (Remember, if neither the IRA holder nor his/her spouse participate in an employer sponsored retirement plan, contributions are always fully deductible.)

Step Three: Determine the estimated Modified Adjusted Gross Income.
Step Four: Determine if you will be 50 years of age or over by December 31 of the tax year for which you are contributing.

Traditional IRA Deductibility Chart

Non-Deductible IRA

Just because you don’t get a tax deduction on the IRA, does not mean that can’t fund it.  The remaining proceeds become a non-deductible IRA if you decide to fund the whole amount.   With the 2010 Roth IRA conversion event just a few months away, this might not be a bad planning strategy, too.

photo credit: justinjovellanos

Securities offered through LPL Financial, Member FINRA/SIPC.