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Eligibility requirements, income limits, tax treatment, and more

Quick Summary

  • Traditional and Roth IRAs offer a tax-advantaged way to save retirement.
  • The biggest difference between traditional and Roth IRAs is when you get the tax benefit.
  • IRS rules determine IRA tax treatment, eligibility, income limits, contribution limits, and more.

An IRA—short for Individual Retirement Account—is a tax-advantaged way to save for retirement. Almost everyone who is under age 70 ½ and has earned income (or has a spouse with earned income) is eligible to open and contribute to an IRA. When you open an IRA, you can invest your money in your choice of stocks, bonds, exchange-traded funds (ETFs), mutual funds, and other investments.

One advantage that IRAs have over other types of non-retirement investments or savings accounts is that IRAs offer certain tax advantages. There are two main types of IRAs, and each carries different tax treatment.

IRA Tax Breaks

The two most common types of IRAs are traditional IRAs and Roth IRAs. (Other types of IRAs such as SEP IRAs or SIMPLE IRAs are set up by an employer or by someone who is self-employed, so we won’t get into those here.)

With traditional IRAs, most people can deduct their contributions from their taxes in the year they contribute that money. For example, if you contribute $6,000, you can deduct $6,000 from your income when you file your taxes. When you withdraw funds in retirement, you pay taxes on it at your then-current income tax rate.

Important: In general, you should pick a Roth IRA if you think your taxable income will be higher during retirement than it is now.

With Roth IRAs, on the other hand, you don’t get a tax deduction in the year you invest the money. Instead, you’re able to withdraw the money tax-free when you retire. That means your contributions and earnings grow tax-free.

Who Is Eligible for an IRA?

You can contribute to a traditional IRA if you’re under age 70 1/2 and have earned income.

For Roth IRAs, you can contribute at any age—young or old—provided you have earned income.

Important: Roth IRAs are an excellent option for younger savers who likely are in a low tax bracket now.

If you don’t have earned income (wages, salary, tips or self-employment) but your spouse does, you can open and contribute to a spousal IRA. These are regular IRA account that married couples use. You can set up a spousal IRA as either a traditional or Roth IRA.

IRA Contribution Limits

For 2019, the annual contribution limit is $6,000, or $7,000 if you’re age 50 or over. The limit applies to both types of IRAs. It also applies to the taxpayer—not the account. That means you can contribute up to a combined $6,000 (or $7,000) to all of your IRAs.

Any money you roll over from another retirement account, such as a 401(k), doesn’t count towards your contribution limit.

No matter what type of IRA you have, your contributions can’t exceed your earned income for the year. For instance, a teenager who works a part-time job is eligible to open and contribute to an IRA (and encouraged to do so). But if they earn less than $6,000 during that year, they can only contribute up to their earned income.

One of the benefits of funding an IRA is the flexible timing. You can contribute to an IRA from Jan. 1 to that tax year’s filing deadline, which is usually on April 15. That gives you 15 months to max out your contributions for the year.

Fast Fact: 6%. The penalty you’ll owe if you contribute too much to your IRA and don’t fix the mistake. 

If you accidentally over-contribute to your IRA, you can withdraw your excess contributions. But until you withdraw that money, the IRS will charge you a 6% tax each year on the excess.

Income and Contribution Limits for Roth IRAs

There are no income limits for traditional IRAs. But if you make too much money, you can’t contribute to a Roth.

The limits are based on your tax filing status for that year. Here’s a rundown for 2019:

2019 Roth IRA Income and Contribution Limits
Filing Status Income (MAGI) Contribution Limit
Married filing jointly or qualifying widow(er) Less than $193,000 Up to the limit: $6,000 (or $7,000 if you’re age 50 and up)
$193,000 to $202,999 Begin to phase out
$203,000 or more Zero (learn more about a “Backdoor Roth IRA”)
Married filing separately (if you lived with your spouse at any time during the year) Less than $10,000 Begin to phase out
 $10,000 or more Zero (learn more about a “Backdoor Roth IRA”)
Single, head of household or married filing separately (if you didn’t live with your spouse during the year) Less than $122,000 Up to the limit: $6,000 (or $7,000 if you’re age 50 and up)
$122,000 to $136,999 Begin to phase out
$137,000 or more Zero (learn more about a “Backdoor Roth IRA”)

Important: If you make too much money, you may still be able to contribute to a Roth IRA using something called a Backdoor Roth IRA

Eligibility and Contribution Rules for Traditional IRAs

With traditional IRAs, you get an upfront tax break. The deductibility of your contributions depends on your income and whether you’re covered by a retirement plan at work.

If you (or your spouse) don’t have an employer-sponsored retirement plan, you can deduct your entire annual IRA contribution. However, if you or your spouse has a retirement savings plan at work, your deduction may be limited.

Here are the details for 2019:

2019 Traditional IRA Eligibility and Contribution Limits
If your filing status is… And your MAGI is… Then you can take…
Single, head of household, qualifying widow(er), married filing jointly or separately and neither spouse is covered by a plan at work Any amount A full deduction up to the amount of your contribution limit
Married filing jointly or qualifying widow(er) and you’re covered by a plan at work $103,000 or less A full deduction up to the amount of your contribution limit
More than $103,000 but less than $123,000 A partial deduction
$123,000 or more No deduction
Married filing jointly and your spouse is covered by a plan at work $193,000 or less A full deduction up to the amount of your contribution limit
More than $193,000 but less than $203,000 A partial deduction
$203,000 or more No deduction
Single or head of household and you’re covered by a plan at work $64,000 or less A full deduction up to the amount of your contribution limit
More than $64,000 but less than $74,000 A partial deduction
$74,000 or more No deduction
Married filing separately and either spouse is covered by a plan at work Less than $10,000 A partial deduction
$10,000 or more No deduction

 

Traditional IRA Withdrawal Rules

With traditional IRAs, there are two main types of withdrawals: required minimum distributions (RMDs) and early withdrawals.

You must start taking RMDs by age 70 ½. Your RMDs are based on your IRA account balance and your life expectancy as estimated by the IRS. The IRS imposes stiff penalties for failing to take your RMDs once you reach 70 ½. You’ll owe a 50% penalty for any RMD you fail to take.

It’s a complex calculation, so many people get advice from an accountant or financial advisor to help determine their required minimum distributions. The IRS also has details about calculating RMDs on its website.

You can start withdrawing money from your IRA as early as age 59 ½ without penalty. But withdrawals made before that are considered early distributions and are subject to additional taxes, except under certain circumstances.

Roth IRA Withdrawal Rules

You can withdraw your contributions at any time, for any reason, with no tax or penalty.

Once you’re age 59 1/2 and the account is at least five years old, you can withdraw your contributions and earnings tax-free (and penalty-free).

If you take an early withdrawal—before age 59 1/2 and/or before the account is at least five years old, you may owe taxes and a 10% early withdrawal penalty. Like traditional IRAs, there are exceptions.

Important: Because there are no RMDs for Roth IRAs, they make excellent wealth transfer vehicles. 

Unlike traditional IRAs, Roths have no RMDs during your lifetime. That means you can keep your money in your account if you don’t need it. Then, your beneficiaries can enjoy years of tax-free growth and income.

How to Invest Your IRA

An IRA allows you to invest in virtually unlimited financial products, including stocks, bonds, mutual funds, ETFs, and lifecycle funds. Most brokerages have a “target-date fund” or “lifecycle fund” based on the year you plan to retire (for instance, 2045 or 2040).

Early on, the fund invests aggressively. But as you approach retirement, the investment choices gradually become more conservative. This can be a good “set it and forget it” option for people who don’t want to actively manage their retirement investments.

Important: Focus on investments that have low fees. A small difference can make a big impact on your nest egg. 

There are certain investments that are off-limits to IRAs, including life insurance, antiques, collectibles, and most coins.

If you have a self-directed IRA (SDIRA), you have even more investment choices, including real estate, These IRAs are only available through firms that specialize in SDIRA services.

As you’re choosing investments, opt for low fees and investment choices you can understand. Many people consult a financial advisor who can help ensure their retirement and other investments are well diversified and appropriate for their goals and timelines.

If you use a financial advisor, ask how he or she is compensated to ensure that you’re not being steered towards high-commission investments. A fee-only financial advisor does not earn commissions and instead charges you for his or her time.

Thanks to the favorable tax treatment, IRAs are one of the most efficient ways to invest and save for retirement. The sooner you start saving, the more your IRA can grow over time

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