1) Q: What is the tax advantage of investing in an IRA account?

A: There are a number of reasons to invest in an IRA account. To start with, the amount invested in a regular IRA is subtracted from taxable income. This translates into tax savings the year the money is invested. This IRA money is only taxed on withdrawal. The deferral of taxes also applies to earning in the IRA. This deferral of taxes allows investments in an IRA account to build faster than regular investments.

Example: A taxpayer makes $50,000 in 2004. The taxpayer puts $3,000 in to regular IRA account and as a result he is only taxed on $47,000. The taxpayer invests the $3,000 IRA in a mutual fund, which earns $100 dividend income in 2005. The $100 dividend income will not be taxed until it is withdrawn from the IRA.

2) Q: What is the tax advantage of putting money in to a Roth IRA account?

A: A Roth IRA works the same way as a regular IRA except funds invested are not deducted from income in the year of investment. The big benefit of a Roth IRA is that when the funds are withdrawn, they are not taxed. This tax-free withdrawal is also true for money earned on the principal IRA money invested.

Example: A taxpayer makes $50,000 in 2004. The taxpayer puts $3,000 into a Roth IRA account. In 2004 the taxpayer is taxed on the full $50,000. The taxpayer invests the $3,000 Roth IRA in a mutual fund, which makes $100 dividend income in 2005. The $100 dividend income will never be taxed so long as the money is taken out at permitted times.

3) Q: Is it better to use a regular or Roth IRA?

A: The decision to use a Roth or regular IRA depends on many factors. One situation where it is especially beneficial to use a Roth as opposed to a regular IRA is when the taxpayer is now in a low tax bracket but expects to reach a higher bracket in the future. In this situation the current tax savings of a regular IRA are usually smaller than the deferred tax savings of using a Roth IRA

Example: A part time student makes $8,000 in 2004. The student is taxed at the lowest tax rate but expects to be earning much more as soon as he graduates school. The student puts $3,000 into a Roth IRA account and is taxed on the full $8,000 he earned in 2004. The tax savings generated by investing in a regular IRA would have been very small. The taxpayer invests the $3,000 Roth IRA money in a mutual fund, which earns $100 dividend income in 2005. The $100 dividend income will never be taxed as long as the money is taken out at permitted times.

4) Q: How much money can I put in to my IRA account every year?

A: During the tax years of 2005 through 2007 a maximum of $4,000 dollars can be invested annually. This amount goes up to $5,000 in 2008. There is a special catch-up rule allowing taxpayers over 50 years old to contribute $4,500 in 2005, $5,000 in 2006 and 2007, and $6,000 in 2008. The contribution rules are the same for both Regular and Roth IRA's.

Example: A 55-year-old taxpayer earns $45,000 in 2005. The taxpayer wants to contribute the maximum he can to a regular IRA. He is able to contribute up to $4,500.

5) Q: Can I contribute to an IRA account for the previous year?

A: You can put deposit funds in an IRA account for the previous year until April 15th. Any contributions made to an IRA after that deadline will be applied to the following year.

Example: A taxpayer prepared her 2004 tax return assuming she had made a $3,000 IRA contribution. On April 20th 2005 the taxpayer remembered that she never contributed the money to her IRA account and makes the contribution that day. The IRA contribution is applied for the 2005 tax year and the tax return is incorrect. An amended return needs to be prepared.

6) Q: When can funds be withdrawn from an IRA account without incurring a penalty?

A: The purpose of the IRA accounts is to encourage people to invest for retirement. To discourage withdrawals, a special 10% tax applies to early withdrawals. This 10% penalty tax is in addition to any other taxes that may apply. At age 59 ½ withdrawals are permitted.

Example: A 35-year-old taxpayer has $20,000 in a regular IRA account. The taxpayer uses the IRA money to buy a new car. At the end of the year the taxpayer will be taxed on the full $20,000 at his regular taxation rate. In addition, the taxpayer will owe $2,000 in early withdrawal penalty taxes.

7) Q: I need my IRA funds to buy a house. Will I be penalized for withdrawing funds prior to my retirement age?

A: A 10% penalty tax is generally levied on early IRA withdrawals. If certain conditions are met there is an exception where these funds are used for a purchase of a primary residence. This works only once for an amount up to $10,000 for qualified first time homebuyers.

Example: A 35-year-old taxpayer has $20,000 in a regular IRA account. The taxpayer uses $10,000 of the IRA money to buy his first home. At the end of the year the taxpayer will not be subject to the 10% early withdrawal penalty.

8) Q: I need the money in my IRA account to pay for graduate school. Will I be penalized for taking this money before my retirement age?

A: A 10% penalty tax is generally added on to early IRA account withdrawals. There is an exemption to this rule if the money is used for education expenses.

Example: A 35-year-old taxpayer has $20,000 in a regular IRA account. The taxpayer uses $20,000 of the IRA money to pay for graduate school. At the end of the year the taxpayer will not be subject to the 10% early withdrawal penalty.

9) Q: I need the money in my IRA account to pay for medical bills. Will I be penalized for using my IRA?

A: A 10% penalty tax is generally added on early IRA account withdrawals. If certain conditions are met there may be an exception where the withdrawn money is used for medical expenses. This only applies to medical expenses that are over 7.5% of the taxpayer's adjusted gross income.

Example: A 35-year-old taxpayer has $20,000 in a regular IRA account. The taxpayer needs to undergo a serious medical procedure and his insurance only covers a small portion of the expenses. The medical bills are higher than the taxpayers entire salary for the year, so the taxpayer is forced to use all of his IRA money and take out loans to pay the medical expenses. In this situation the taxpayer will not be subject to the 10% early withdrawal penalty.

10) Q: I earned interest on money I have invested in my IRA. Do I need to report this on my tax return?

A: You do not need to report or pay taxes on these earnings until it is withdrawn from the IRA. When the money is taken all taxes must be paid at regular income rates.

Example: A taxpayer has $9,000 in his IRA invested in a money market account. He does not have to report this income because taxes will only be due when he takes the money out of the account.