Contributions to a deductible IRA are just that, deductible. You can contribute up to $2000 per year. To be eligible for the deduction, you must have an earned income and not be covered by an employer-maintained retirement plan. If you do participate in an employer's plan, you may still qualify for the deduction if your adjusted gross income is below a certain level. All of your earnings in this IRA remain tax deferred until you begin making withdrawals. At that time, they will be taxed as income in the current year. In most cases, if you withdraw funds from your deductible IRA before age 59 1/2 you will incur a 10% penalty.
In contrast, contributions made to a non-deductible IRA are not deductible. However, the earnings do grow tax free until they are withdrawn, which can add up over time even if you don't qualify for the deductible IRA. As with the deductible IRA, the non-deductible IRA allows you to contribute up to $2000 per year. For both of these IRAs, you must stop contributing and begin deducting at age 70 1/2.
The third type of IRA is the newest. It is the Roth IRA. To be eligible for the Roth IRA you must have earned income and an adjusted gross income below certain limits. Although your contribuitons of up to $2000 per year are not deductible, your withdrawals are tax-free, which is very appealing to those who expect to be in a higher tax bracket when they retire. To receive the withdrawals tax-free certain qualifications must be met, including a 5-year holding period, reaching age 59 1/2, a first-time home purchase, permanent disability, or death. You can contribute to a Roth IRA even if you participate in another retirement plan. Both the deductible and non-deductible IRAs can be converted to the Roth IRA if your adjusted gross income is below $100,000 (unless you are married filing single, then conversion is not allowed).
One important thing to know is that $2000 per year is the total amount you can contribute to any combination of IRAs. That means for example, if you contribute $1000 to a deductible IRA the most you could contribute to a Roth IRA would be $1000 for the year. These are just the basic differences between IRAs and you should do more research on your own if you are considering investing in an IRA. One good place to find more information regarding IRAs is at the Motley Fool website. Who ever thought IRAs could be so exciting?
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