What is a Contributory IRA?
Updated: May 20
We've all got to retire at some point, so the sooner you start setting aside retirement savings, the better. It's not as simple as walking up to your boss and saying you want to set up a retirement plan, though.
First off, there are different types of accounts that you need to consider. The name of one of these is a contributory, or traditional, IRA. While we're focusing strictly on this type in this article, it's not the only option you have.
You may feel a traditional IRA isn't for you by the end of this, so don't be afraid to consider your other services and options. Your retirement savings are no matter to be taken lightly, after all.
Don't put your name on something that you aren't happy with.
What is a Contributory IRA?
A contributory IRA, or contributory individual retirement account, is another name for a traditional IRA. It's technically an investment account that is designed specifically for retirement.
One of the most common types of retirement accounts primarily for the attractive tax benefits it offers. You get these benefits both when you make a deposit and throughout the lifespan of the account.
You do have a contribution limit and a withdrawal limit on your funds in the account, though.
You're only able to contribute earned income into your traditional IRA, which includes the likes of wages and your salary, and not the income that you may have gotten from services connected to your name.
The contribution limits on the account vary from situation to situation. If you're single and under 50, you can only deposit $5000 of income per year. If you're over 50, that number gets bumped up to $6,000.
However, if you're married, you can make contributions of an additional $5,000 annually so long as your taxable compensation is over the amount of your contribution.
Tax Benefits of a Contributory IRA
One of the account's main attractions is that your tax contributions are deferred until distribution, regardless of how much your total investments are. All of the funds you've put into the account remain untaxed until you decide to withdraw them.
This means that your income compounds year on year at a higher rate, which can be invaluable throughout a lifespan.
There is an additional tax put on early withdrawals by the IRS, though. If you decide to take money out of your contributory IRA before you retire, you're going to be subject to a 10% tax on that money, provided you're under 59.
This isn't a blanket rule, though. There are exceptions to withdrawing from an individual retirement account that you must adhere to, such as funds needs for education, medical, and housing expenses.
The Three Different Types of IRA
There are three types of individual retirement accounts, each with a different name, that we want you to consider. One of these is the traditional IRAs that we just talked about, but two other IRA contribute options that are worth your time.
Roth IRAs are much different from the other two types you have the choice of. It's also the type of account that has been making the most waves in recent years.
One of the major differences between traditional and Roth IRAs has to do with contributions and distributions. Specifically, it's that your income is taxable at the time of deposit. As a result, the deposits that you make are not considered tax deductibles.
To balance that out, though, none of the income in your name is taxed when you make your withdrawal, which is arguably better than the alternative. It means that your income in the account grows tax-free, which may be an attractive option compared to another type of IRA.
After you hit 59, you can partially or fully withdraw from Roth IRAs completely tax-free. Like contributory, or traditional, IRA plans, there are exceptions to this rule.
Specifically, the withdrawal must be for a predetermined qualified reason, and five years must have passed since you opened the account. Qualified reasons must include the likes of medical services, educational pursuits, or the purchase of a new home in order to have access to the distributions. Your name must be attached to these expenses.
If you need to withdraw early and don't have a valid reason, the withdrawal is subject to a 10% tax like a contributory IRA account.
One of the more attractive aspects of Roth IRAs, though, is the fact that there are no rules regarding when your funds must be withdrawn. You could leave the account to an heir if you wished.
Traditional and Roth IRA accounts are the most popular types of IRA accounts out there, so if you qualify for one of these, you should take the agreement. Otherwise, you're going to be limiting yourself in terms of annual contributions and annual distributions.
There is one major difference between non-deductible IRAS and traditional IRAs. This difference is in the ability to consider early contributions as a tax deduction every year. Your non-deductible contributions are taxed as typical income at the time of deposit and cannot be taken away from your gross income.
When you take money out of a non-deductible IRA, you're only subject to an income tax on the earnings as your yearly contribution has already been paid.
What this means for you, though, is that your contributions and earnings get tax-deferred growth. Like the other two types of IRAs, you can begin withdrawing from the account once you turn 50. Also, like the other two, you are subjected to a 10% tax for early withdrawals.
Once you hit 70, you are required to start withdrawing from the account every annual calendar so that it empties based on your life expectancy.
Non-deductible IRAs have a clear number of drawbacks when compared with the other two, but it does present an option for those that don't qualify for a contributory or Roth account. Despite not having as attractive annual contributions or distributions, it is worth taking this account if you don't qualify for the other types of IRA.
Your IRA Account and Your Employer
When you set up a contributory IRA account, you sign an agreement with your current employer. This agreement highlights a number of areas surrounding your retirement savings, contributions, mutual funds, and other investments, as well as your overall plan and investments.
Specifically, though, it covers what happens if you leave your current job. The rules of moving your money between two different retirement plan IRAs are simple to understand.
AS a fundamental rule, you must wait two years after opening your contributory IRA to move the money to another account. This means that if you leave your current job in under two years from setting up the IRA, you don't have access to the money until that time period runs out.
However, this rule doesn't apply if you're transferring money between two traditional IRAs. Therefore, if your new job also offers a traditional retirement plan IRA, then you don't have to wait at all.
If you do decide to break the two year rule and move the money to a non-traditional account, you are subjected to a 25% tax penalty.
Once your two year period is up, you can move your contribution fund to a non-traditional or 401 K account via Roth conversion, transfer, or rollover.
An IRA rollover allows you to take the fund investment that you have in your old financial individual IRA and move it into a new one while keeping yourself free from additional taxes.
This type of retirement plan has a number of investment choices for you to choose from based on your age, gross income, and personal finance.
These options include CDs, ETFs, bonds, stocks, and more.
Your Contributory IRAs Investment Options
When you sign your name to an IRA contribution agreement with your employer, you're going to put to paper that you agree to a lot of regulations. You get informed about the tax deduction, contribution limits, year withdrawals, as well as other data and services.
However, you also get offered the option of where you want your IRA contribute money to go. As we mentioned in the section above, you have a number of options at your disposal here.