Financial Independence (Getting to Point X) by John J. Vento

Author:John J. Vento
Language: eng
Format: epub
ISBN: 9781119510352
Publisher: Wiley
Published: 2018-08-26T00:00:00+00:00

If you do not qualify for a tax‐deductible contribution, you can always make a full nondeductible contribution, to the extent of earned income. This will require you to keep track of your basis in the IRA with the IRS by completing Form 8606, which must be included with your personal tax return. Once you start making distributions, you will not be taxed on the portion of the distribution that is considered a return of your basis (nondeductible contribution). I would only recommend making nondeductible contributions if you do not qualify for a Roth IRA contribution.

The money in a traditional IRA grows and compounds on a tax‐deferred basis – which means you will not pay taxes until you start receiving distributions after you retire. Many retirees are in a lower tax bracket during this stage of their lives. Therefore, your tax rate and the overall amount of taxes you save when making these contributions may be much greater than the amount of taxes you will pay on the distributions in retirement. Although withdrawals are taxed as ordinary income, many states have special exclusions which may result in little or no tax paid at the state level on these distributions.

The IRS gives you all of these significant tax‐advantaged savings in order to encourage you to be responsible and save for your retirement. However, the IRS will also penalize you if you take distributions from your retirement account before you reach age 59½ – once again to encourage responsible savings for retirement (because obviously, if you are withdrawing from your retirement account before you are retired, that will deplete the money that is supposed to be there for you when you retire). In addition to paying income tax on these withdrawals, you may also be subject to a 10% federal income tax penalty.

There are some exceptions to the early withdrawal penalty:

If you withdraw money as a result of a disability,

If you use that money to pay for medical insurance while you are unemployed, or

If you use that money to pay for higher‐education expenses.

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