A contributory individual retirement arrangement is another name for a traditional IRA, which is an investment account specifically designed for retirement savings. Contributory IRAs are attractive due to the tax benefits they offer, both at the time of deposit and throughout the life of the account. Restrictions apply to both contributions and withdrawals.
You can only contribute earned income to a traditional IRA, such as income you earn from your wages or salary. As of 2012, the annual cap on contributions is $5,000 -- $6,000 if you're age 50 or older. If you have a non-working spouse, you can contribute an additional $5,000 on his behalf, as long as your total taxable compensation exceeds the amount of your contribution.
If neither you nor your spouse are covered by a retirement plan at work, you can take a tax deduction equal to the entire amount of your IRA contribution. If you are covered by a plan, your deduction begins phasing out at $90,000 of adjusted gross income if you are married and filing jointly, with no deduction allowed with an AGI of $110,000 or above. If your spouse is the one covered by a plan, the phaseout begins at $169,000 of AGI, with the elimination of the deduction kicking in at $179,000 or more.
One of the main benefits of a contributory IRA is that the taxes on your investments are deferred until distribution. No matter how much interest you earn, or how many capital gains you realize, all of the profits in the account remain untaxed until you withdraw them. If you received a deduction for your contributions, that money is also taxable upon distribution.
Since a contributory IRA is meant to fund your retirement, early withdrawals carry an additional penalty tax. The IRS will apply a 10 percent tax to any money you take out of a contributory IRA before you turn 59 1/2. There are some limited exceptions to this rule, including distributions used for certain educational, medical and housing expenses.
Once you turn 70 1/2, the IRS will expect you to begin taking annual distributions from your contributory IRA. Your first withdrawal must come by April 1 after you turn 70 1/2, and your subsequent distributions must come out no later than Dec. 31 every year. The penalty for failure to take your required minimum distributions is 50 percent of the amount that should have been distributed.
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