Individual retirement accounts provide tax advantages to those who are saving for retirement. Before investing in an IRA, it can be helpful to understand the guidelines, including how much you can deposit in the account each year, what sort of tax savings you will receive and when to withdraw funds.
As you plan your IRA savings strategy, consider the following:
— IRA contribution rules
— IRA tax deduction rules
— IRA withdrawal rules
— Traditional IRA income rules
— Roth IRA rules
IRA Contribution Rules
The IRS has limits on how much can be contributed to an IRA. In 2024, your total contributions to all IRAs cannot be more than $7,000 if you are age 49 or younger and $8,000 if you are 50 or older. You typically have until the tax-filing date of the following year to make the contribution. For instance, if you are 30 years old and save $5,000 in 2024 in a traditional IRA, you can add up to $2,000 by April 15, 2025.
You need to have earned income from a job or business to be eligible to contribute to an IRA. When putting money into an IRA, you won’t be able to add more than the amount you make. If you earn $1,000 a year, you’ll be eligible to contribute up to $1,000 to the IRA.
There is an exception to the earned income requirement for married couples. If you are married and your spouse doesn’t work for pay, you may be able to open and contribute to a spousal IRA. For this type of account, the limits are the same for earned income, meaning you won’t be able to save more than your total wages. “Unlike a few other retirement avenues, IRAs don’t impose an upper age limit for contributions as long as you’re still generating income,” said Joseph Carpenito, a financial advisor at Materetsky Financial Group in Boca Raton, Florida, in an email.
[READ: IRA Versus 401(k): Which Is Better?]
IRA Tax Deduction Rules
You may be able to defer paying income tax on the amount you contribute to an IRA. The exact deductible amount will depend on what other retirement accounts you have.
“If neither you nor your spouse is covered by a company retirement plan, you can deduct the full amount of your annual contribution, no matter how much money you make,” said Mike Piershale, president of Piershale Financial Group in Barrington Hills, Illinois, in an email. If you or your spouse has a retirement plan through work, such as a 401(k), the amount you will be able to deduct is based on your income and tax filing status.
If you are a 401(k) participant who is taxed as an individual and earns more than $77,000, you won’t be able to deduct the entire IRA contribution. In this case, there is a phase-out range that caps at $87,000. If you earn more than $87,000, you won’t be able to make a tax-deductible IRA contribution.
For married couples filing jointly, if the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is between $123,000 and $143,000. If you earn more than $143,000 as a joint filer with a 401(k), you cannot deduct your IRA contribution.
For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the phase-out range begins at $230,000 and is capped at $240,000.
[READ: Deciding Between a Roth vs. Traditional IRA.]
IRA Withdrawal Rules
You can expect to pay income tax on each withdrawal from your traditional IRA. If you take out pretax IRA contributions before age 59 1/2, you will also typically face a penalty, which is 10% of the amount withdrawn. This means a distribution of $15,000 before age 59 1/2 would be treated as income and create a $1,500 tax penalty.
“If you are over the age of 59 1/2, then only income tax would apply — no early distribution penalty,” said Adam Bergman, president of the IRA Financial Trust Company in Sioux Falls, South Dakota, in an email.
However, there are some penalty exemptions for specific circumstances such as a job loss or high medical expenses.
When you reach age 73, you’ll need to take required minimum distributions from your IRA every year until the IRA is depleted. “The average RMD is approximately 3% of the value of the IRA as of Dec. 31 of the prior year,” Bergman said. You can make estimates to see if the withdrawals, Social Security and other sources of retirement income will be enough to cover your regular living expenses.
[Related:7 Things to Know About Withdrawing Money From a Traditional IRA]
Traditional IRA Income Rules
If you have a traditional IRA, you can place money into it, provided you meet the requirements. You’ll need to have earned income to make a contribution to a traditional IRA.
If you think you’ll be in a lower tax bracket during retirement, it could be wise to make traditional IRA contributions while working. This way, you could have your taxable income lowered in your career years. The distributions will be subject to taxes later when you are not bringing in a steady salary from being employed.
Roth IRA Rules
Not everyone is eligible to contribute to a Roth IRA. If your income is above a certain level, the option isn’t available. For instance, if you are married and file a joint tax return, you won’t be able to contribute if your income exceeds $240,000.
“If you are over the income threshold for contributing directly to a Roth IRA, you might still benefit from contributing to a traditional IRA,” said Kevin Lao, a certified financial planner and founder of Imagine Financial Security in St. Augustine, Florida, in an email. “In this situation, you will also be above the income threshold to qualify for a tax deduction, but you could take advantage of what is called a Roth conversion.” This consists of converting some or all of your traditional IRA into a Roth IRA. “There is no income threshold for who can qualify for a Roth conversion,” Lao said.
When contributing to a Roth IRA, the amount you put in will not be tax-deductible. Earnings from the account are not subject to taxes if you meet certain requirements before taking them out. Once you’ve had the account open for five years and are at least 59 1/2, you can begin to take out earnings without facing penalties and taxes.
In addition, you can take out the original contribution amount at any time. It won’t be subject to taxes or penalties. “If most of your retirement savings is held within tax-deferred IRAs, you might consider diversifying into tax-free buckets, including a Roth IRA,” Lao said. “That way, you aren’t betting on one tax outcome over the other.”
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IRA Rules: Contributions, Deductions, Withdrawals originally appeared on usnews.com
Update 08/29/24: This story was previously published at an earlier date and has been updated with new information.
