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Originally Posted by uhohNumber2brb
if i contributed $4k to Roth IRA, I would get $600 more back....
dont they tax you when you take the money out???
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Since Roth IRA contributions are not deductible, it would not change or increase your refund amount. However, if you contributed $4000 pretax to a Traditional Contributory IRA, you receive an equal amount of deduction against ordinary income. If you are in the 15% fed bracket, it would be worth $600 in tax savings. Assuming the same rate of W-2 with holding, you would indeed receive $600 more in your refund. But NOT with a Roth IRA.
Normal distributions from a Roth IRA are considered a return of principal and not taxed until you return all of your original contributions. Then, as earnings are taken, you pay ordinary income tax on those distributions. Although you forfeit the initial tax deduction, don't be seduced by the Traditional IRA deduction alone, certain characteristics of Roth IRAs may make them much more attractive, particulary to younger investors.
Regarding deductibility of Traditional IRA contributions, you may or may not be able to deduct all of your IRA contributions from gross income. Eligibility for this deduction is determined by the person's modified adjusted gross income (MAGI), the person's filing status on their 1040(-A, -EZ) form, and whether the person is eligible to participate in an employer-sponsored pension plan or contributory plan such as a 401(k). To compute MAGI, you include your federally taxable wages (i.e., salary after any 401(k) contributions), investment income, business income, etc., then subtract your adjustments (not to be confused with deductions) other than the proposed IRA deduction. In essence, the MAGI is the last line on the front side of a Form 1040 with no IRA deductions.
Anyhow, if your filing status is single, head of household, or equivalent, the income test has limits that are lower when compared to filing status married filing jointly (MFJ). These income tests are expressed as ranges. Briefly, if your MAGI is below the lower number, you can deduct everything. If your MAGI falls within the range, you can deduct some portion of your IRA contribution. And if your MAGI is above the upper number, you cannot deduct any portion. (No longer does coverage of one spouse by an employer-maintained retirement plan influence the other's eligibility.) The income tests for 2005 looked like this:
Not covered by a pension plan: fully deductible.
Covered by a pension plan:
- MAGI less than 50k (MFJ 70k): fully deductible
- MAGI in the range 50-60k (MFJ 70-80k): partially deductible
- MAGI greater than 60k (MFJ 80k): not deductible
If your filing status is "Married Filing Separately" (MFS), then the income restriction is much tighter. If your filing status is MFS and both spouses have a MAGI of $10,000 or more, then neither spouse can deduct an IRA contribution.
It's important to understand what it means to be "covered" by a pension plan. If you are eligible for a defined benefit plan, that's enough; you are considered covered. If you are eligible to participate in a defined contribution plan, then either you or your employer must have contributed some money to the account before you are considered covered. IRS Notice 87-16 gives all the gory details about who is considered covered by a pension plan.
SDG35619 - distributions from a Traditional IRA are simply taxed as ordinary income according to your income tax bracket. Premature distributions (before the IRA owner reaches age 59-1/2) are subject to an additional 10% early withdrawal penalty by the Fed.
Got it?
[edit] opps forgot - IIRC, you can take a penalty-free withdrawal of up to $10,000 from any type of IRA to purchase a first home for yourself, your spouse, your child or spouse's child, your grandchild or spouse's grandchild, your parent or other ancestor, or your spouse's parent or other ancestor. A 'first home' actually means the person's first home within the last two years.
DISCLAIMER: I stayed at a Holiday Inn last night but I ain't a tax professional... except, it seems, when it comes to paying. Bah...
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