- To contribute to a traditional IRA in any year, you must report taxable income to the Internal Revenue Service and be younger than 70 1/2 years old. If you meet qualifications, you may only contribute $5,000 a year to your fund, or $6,000 if you're age 50 or older, as 2011. In addition, you may only contribute an amount equal to your taxable income, so if you only earned $2,500 in a tax year, that's the maximum amount you may contribute to your traditional IRA, regardless of your age. If you contribute more than your limit one year, you will incur a penalty, although you may credit the excess to the following year, provided you don't exceed contributions that year.
- Many contributions you make to your traditional IRA may qualify as deductions or tax credits. You may claim investments up to your contribution limit as a non-itemized deduction -- which allows you to claim the standard deduction if you choose -- on your 1040. These contributions reduce your taxable income and, in turn, lower your tax liability. If you're born before Jan. 2, 1993, are not a full-time student or a dependent and earn less than $27,750 if filing individually, or $55,500 if you're married and filing jointly, you may claim a $1,000 -- $2,000 for couples -- retirement savings contribution credit, a dollar-for-dollar reduction of your tax bill.
- You must begin taking minimum distributions when you reach 70 1/2 years old, or you face an excise tax. If you claimed contributions as deductions in previous years, distributions are treated as ordinary income and taxable at the rate appropriate for your tax bracket. If you tap your traditional IRA before it matures when you turn age 59 1/2, an additional 10 percent tax is assessed on top of income tax rates for the amount withdrawn.
- Two tax differences separate traditional and Roth IRAs. Contributions to Roth IRAs aren't deductible, and they are, therefore, after-tax contributions. The Roth IRA contributions won't lower your taxable income for the year in which you make the contributions. However, all distributions from a Roth IRA are not taxed, provided they are taken after you reach age 59 1/2.
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