There are two types of IRAs, Traditional IRAs and Roth IRAs, both of which are discussed in this Financial Guide. Traditional IRAs defer taxation of investment income and withdrawals are taxable income–except for withdrawals of previously non-deductible contributions. In most cases, however, contributions are deductible. Roth IRAs are subject to many of the same rules as Traditional IRAs, but there are several differences, the primary one being that contributions are not deductible and are made after tax. As such, qualified distributions are generally tax-free.
If you have income from wages or self-employment income, you can contribute up to $6,000 in 2019 ($5,500 in 2018). As such, IRAs are available even to children who meet these conditions. Persons age 50 and older can contribute an additional $1,000 for a total of $7,000 in 2019.
Yes. Contributions of $6,000 for each spouse are allowed in 2019 ($5,500 in 2018) if the couple’s wages or self-employment earnings are $12,000 or more.
Roth IRAs offer the following advantages:
Not everyone can have a Roth IRA. The following conditions apply:
Yes, subject to the income conditions above. This allows contributions of $5,500 each if the couple’s earnings are at least $12,000 in 2019 ($13,000 if only one of you is age 50 or older or $14,000 if both of you are age 50 or older).
Yes, for a child with personal service earnings, and subject to the other income conditions.
The following is a brief list of negative issues regarding Roth IRAs:
Under the new tax reform law, for taxable years beginning after December 31, 2017, if a contribution to a regular IRA has been converted into a contribution to a Roth IRA, it can no longer be converted back into a contribution to a regular IRA. This provision prevents a taxpayer from using recharacterization to unwind a Roth conversion.
The income limit was permanently removed for tax years starting in 2010. Anyone, even those with high incomes, can convert from a traditional IRA to a Roth IRA.
When you convert from a traditional IRA to a Roth IRA you pay taxes on the value of your account as of the conversion date. If your account loses value and the account is worth less money you’ll end up paying taxes on money you no longer have in your account.
Say you convert $50,000 in a traditional IRA to a Roth IRA and the value drops to $35,000. If you didn’t make any nondeductible contributions, the taxable distribution would be $50,000 and that would be the amount you would be paying taxes on. However, now your account is only worth $35,000. By re-characterizing the account you can avoid paying taxes on money you no longer have ($50,000). You’ll be back to a traditional IRA, but of course, the account is now worth only $35,000.
Prior to 2018, the IRS allowed you “re-characterize” the account back to a traditional IRA, essentially putting you right back where you were – at least tax-wise. However, tax reform legislation passed in 2017 repealed this special rule and re-characterizations are no longer permitted.
Your heirs are taxed as follows:
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