The Individual Retirement Account (IRA) is the most important building block in your retirement plan. This is because of the significant tax benefit you will receive if you invest your money within an IRA.
Congress created the IRA in 1974 to provide tax incentives for Americans to save more for their retirement. There are a number of different types of IRAs (Traditional, SEP, SIMPLE, Self-Directed, and Roth). For this article, we will look at the rules associated with a Traditional IRA.
Here’s how a Traditional IRA works:
• Money contributed to an IRA is not taxed that year.
• Interest earned on these contributions is not taxed as long as it remains within the IRA.
• The contributions and interest are taxed when they are taken out of the IRA.
The impact of investing in a Traditional IRA is that your money will grow faster than if you invest your money outside of an IRA. To take advantage of the Traditional IRA tax benefits, you should understand its rules.
Contribution Limits
For 2011 and 2012, the maximum you can contribute each year is $5,000. If you are age 50 or older, you can contribute up to $6,000. Your earned income must be equal to, or greater than, your IRA contribution.
For example, if you are self-employed and have a profit of $4,500 for the year, the maximum you can contribute is $4,500. The contribution to the IRA does not have to come from the person who earned the money. Let’s say your daughter earned $1,000, but has spent it. You could give her $1,000 so she can contribute to her own IRA.
Eligibility
Whether or not you are eligible to contribute to a Traditional IRA depends on your filing status, your modified adjusted gross income, and whether you are covered by a retirement plan at work.
If you are not covered by a retirement plan at work and you are:
• Single, head of household, a qualifying widow(er), married filing jointly or separately with a spouse who is not covered by a plan at work – you are entitled to contribute the full amount
• Married filing jointly with a spouse who is covered by a plan at work – you are entitled to contribute the full amount if your modified adjusted gross income is $169,000 or less ($173,000 for 2012). You are entitled to a partial deduction if your modified adjusted gross income is more than $169,000 but less than $179,000 ($173,000/$183,000 for 2012).
• Married filing separately with a spouse who is covered by a plan at work – you are entitled to a partial deduction if your modified adjusted gross income is $10,000 or less (2011 and 2012 limits).
If you are covered by a retirement plan at work and you are:
• Single or head of household – you are entitled to contribute the full amount if your modified adjusted gross income is $56,000 or less ($58,000 for 2012). You are entitled to a partial deduction if your modified adjusted gross income is more than $56,000 but less than $66,000 ($58,000/$68,000 for 2012).
• Married filing jointly or a qualifying widow(er) – you are entitled to contribute the full amount if your modified adjusted gross income is $90,000 or less ($92,000 for 2012). You are entitled to a partial deduction if your modified adjusted gross income is more than $90,000 but less than $110,000 ($92,000/$112,000 for 2012).
• Married filing separately – you are entitled to contribute the full amount if your modified adjusted gross income is less than $10,000 (2011 and 2012 limits).
For more details, see IRS Publication 590 Individual Retirement Arrangements.
Withdrawals
You can begin withdrawing from your IRA after you reach age 59 ½. If you withdraw before this time you will pay a 10% penalty. Therefore, don’t make a contribution to your IRA unless you are confident that you won’t need the money until then. There are, however, certain circumstances where you can withdraw money before reaching age 59 ½ without paying this penalty:
First-time home buyers: you can withdraw as much as $10,000 for a first home, or $20,000 if you are married and your spouse also has an IRA. Be aware that the time limit from when you withdraw the money and when you spend it is 120 days.
Costs involved with education: This includes all education after secondary education and can be a college, university, or even a vocational college. Costs allowed include more than just tuition, and can be for books, supplies, and even room and board, with certain limitations.
Disability: if you are disabled and cannot work full time you may also withdraw money from your IRA. Your disability will have to be verified by a doctor.
Medical expenses: You may also withdraw money for medical expenses, but the amount cannot be greater than 7.5% of your adjusted gross income. You must show a real need for the money in your IRA to help with your unforeseen medical costs.
Health insurance while unemployed: If you have lost your job and your health insurance, you may withdraw money from your IRA to help pay for premiums on your health insurance. You must have been collecting unemployment insurance for at least one year.
There is also an exception if you are called to active duty in the U.S. Armed Forces or if the IRS has slapped a levy on you.
For details of all these exceptions, see IRS Publication 590.
Note: Once you reach age 70 ½ you must begin withdrawing money from your IRA. The IRS has rules that determine the minimum distribution you must make each year or face a penalty.
Deadlines: You can set up and make contributions to an IRA by the due date of your tax return (April 15). This deadline is the same even if you have an extension to file your tax return.
Conclusion
Don’t let the various rules involving a Traditional IRA get in the way of establishing and contributing to an IRA. It’s vital to retirement planning.
Is there a penalty if I lost my job and I don’t have money to pay my morgage and I want to get money from my IRA account?
Yes, there is a 10% penalty for withdrawing money before you are 59 1/2 years old. If you are over 59 1/2, there is no penalty. If it is a traditional IRA you will also have to pay taxes on the money you take out. Not so with a Roth IRA. There are some exemptions like medical expenses, and if this was for a down payment on your first home, but I don’t think home mortgage qualifies. You can find more info here: http://www.ira.com/withdraw-money-early-ira-without-penalties – Also, please ask your IRA administrator for more details.
Once I start taking distributions from my IRa’s (I am 64) , is there a set amount every year that I must withdraw if I am under 70? In other words, once I start to take out money before I am 70, must I take the same amount every year, or can I skip a year? Thank you.
Money you withdraw between the ages of 59 1/2 and 70 1/2 is completely at your discretion. You can draw on money at any time and any increments. It’s not until you reach age 70 1/2 that you must begin taking your minimum requirements at regular intervals.
I inherited an ira from my mom $14,ooo,my accountant is sending me a form stating a $900 return I dont understand whats its for. I want to transfer the Ira out of her name and put one in mine but he says I can only do$6000 and cash out $8000 and get taxed on the $8000 what will be the penalty in taxes on that $8000
I am not an accountant, but the regular rules say that only a spouse can rollover an IRA without incurring taxes. Since the money is coming from your mother, you are going to have to pay taxes on it, just like you would any inheritance. In fact, you are actually liable for the taxes on the whole $14,000. But, since you plan on starting your own IRA, you are able to then get a tax deduction on the amount you plan to deposit into your new IRA. If you are under 50 years old, you can only deposit $5000 a year into an IRA. If you are over 50 years old, you can deposit $6000. I am going to take a guess that you are 50 years or older. Is that correct?
Now, there is one thing you can do if you are married. If so, you can also set up a Spousal IRA. This is only the case if your spouse does not have an IRA that they’ve already contributed the yearly maximum to. Let’s say you are married, your spouse does not have his or her own IRA, and is over 50 years old as well. Then you can set up this spousal IRA (you must be filing jointly) and thus you can deduct that $6000 twice, or $12,000. If you are single, or your spouse has already received their deduction for the year for their own IRA, then yes, $6000 is all you can deduct for opening your own IRA. See more on the spousal IRA here: http://www.ira.com/spousal-ira – (This type of IRA that is tax deductible is called the Traditional IRA. Be aware that there is also what is known as a Roth IRA, but that type is not tax deductible at the time of deposit.)
Remember that this money is inherited money and I’m sure there are other types of tax shelters available. What you are referring to here is just that $6000 you can get for opening your own IRA. There are all kinds of tax shelters out there, and if you find some you can further shield that $8000 from taxes. I hope this helps. Please feel free to ask if you have more questions.
in-laws 86 and 92. both in skilled nursing home. 92 year old has $22,000 in an IRA. 86 year old spouse has $6,000 in another account. both have filed jointly for 10 years and have filed simple form, no tax deductions.
92 year old has taken required distributions since 70.5 years old. can they use all their money without penalty?
Yes, both in-laws can take as much as they want out of their IRAs without penalty, since they are both over age 59 1/2. The required minimum distribution is just that – minimum. There is no maximum limit they can withdraw.
Can a SEP IRA be initially funded with a rollover from a traditional IRA or 401(k)?
Yes, you can establish a SEP IRA (without funding it initially) and then make the first contribution with your rollover from a traditional IRA or 401(k). If you do this as a direct transfer, you won’t have to worry about the possibility of paying taxes on rolled over funds.
Are the income limitations figured on the combined income of a married couple? For example, can husband who earns $10,000 contribute $6,000 to his IRA when spouse has 401K and earns over $179,000. Husband’s income is below limit, but if his income is combined with spouse (they file jointly), it exceeds limit. Thank you
Yes, you must use a husband and wife’s combine income (modified adjust gross income) when they are filing jointly, to determine eligibility for an IRA. So, if the husband’s income is below the limit, but the wife’s income is above it, together they don’t qualify.
Can you close out an IRA and move the money to a 401k?
If you are an employee, you cannot roll over money from a personal IRA into your employer’s 401k plan.
I’m over 70, How do I know what to with draw at age 70 1/2, Thank You
Here’s what the IRS says:
“How much must I take out my IRA at age 70 1/2?
Required minimum distributions apply each year beginning with the year the account owner turns age 70 1/2. The required minimum distribution for each year is calculated by dividing the IRA account balance as of December 31 of the prior year by the applicable distribution period or life expectancy. An account owner can determine his or her applicable distribution period or life expectancy by using the Tables in Appendix C of Publication 590. Table I is used by beneficiaries. Table II is for use by owners who have spouses who are both the IRA’s sole beneficiary and who are more than 10 years younger than the owner. Table III is for use by all other owners.”
See: http://www.irs.gov/retirement/article/0,,id=111413,00.html#8
I retired in August 2011 at age 60 and began receiving distributions from my pension. Would it be okay for me to contribute to my IRA for 2011?
Yes, you can continue to contribute to a Traditional IRA until you reach age 70 1/2.
I recently retired at age 60 and have 401k savings in account with former employer. A I allowed to rollover the savings from 401k account into an IRA?
Thanks
May I, after transfer, lawfully consolidate the assets of two IRA accounts, as well as the assets of one 403(b) account, into a single new Traditional IRA account, or must I open three separate accounts and not commingle the assets of the three current (2 IRAs, one 403(b))accounts? Thank you!
No. You cannot commingle the assets of three different IRA accounts. Sorry, wish we could.
James – Yes, you can rollover your 401k account into a private IRA. Contact the company where you want to rollover your money and they can help you with the rollover from your 401k.
I want to know if I can roll over my 401K to an IRA, and if so which IRA is the best to get return on. I am 59-1/2 and had to stop putting money into my 401K 1-1/2 years ago. I only have $3900.00
Yes, you can roll over your 401k to a personal IRA. The return you get on your IRA investment has nothing to do with the type of IRA you choose. First you choose your investment (among the thousands of choices of mutual funds, etc.) and then you label your investment as one of the types of IRAs (Traditional, Roth, SEP, SIMPLE, etc.). In other words, you aren’t investing in an IRA, you are identifying your investment as an IRA. Therefore, no IRA is a better investment than another. It’s the investment within your IRA which will determine your return.
I enjoyed reading your article. I withdrew about 20K last year
and have to pay the penalty this year am not sure what the taxes are
on this amount can I give them a reason after a year or not.
Thanks your article was very informative and accurate. Thanks again
LOU
If you don’t roll over your IRA within 60 days of withdrawal, you will owe a 10% penalty. There are, however, a couple exceptions to paying this penalty. If you buy a home as a first-time home buyer, you can distribute up to $10,000 within 120 days. If the financial institution makes an error in the rollover, you can also avoid the penalty. There are also hardship exceptions involving death, disability, incarceration, hospitalization, restrictions imposed by a foreign country or postal error.
If none of these exceptions apply to you, then you must report the rollover amount as ordinary income on your tax return (in addition to the 10% penalty).
I max out my Roth IRA contribution every year. However, my company 401k now offers a Roth Option. Can I do both? Is there an annual limit on Roth 401K contributions?
I turned 70 in November of last year and will not be required to take a R.M.D. on my traditional IRAs until 2013. I don’t think I can make any additional contributions this year but could I still execute a transfer between institutions this year?
D. Hasa – Yes, there is no age limit to when you can do a rollover or transfer of your funds.
Adam – Yes, you can contribute to both a personal Roth IRA and a designated Roth IRA account through your employer. Contributing to both does not reduce the amount you can contribute to the separate Roth accounts.
If your adjusted gross income is over the limit, can you still contribute and just not take the deduction? If so, are the gains taxed the same way?
I have a 401k at work but my employer dosen’t match or contribute to it. My adjusted income is over 150,000 per year. Is this considered a “plan” and therefore I do not qualify for an IRA
If you are not eligible to make a deductible IRA contribution, you can establish a non-deductible IRA, using Form 8606.
Chris – You are considered to be covered by an employer plan, even though the employer doesn’t make a contribution to it. Since your income it too high, you cannot qualify to set up and contribute to a Traditional IRA. However, you are eligible to set up a Roth IRA, assuming you are married and filing jointly.
I`m 64 years old and early retired, with a Mobil Repair Business.
Wich is the maximum amount that I need to open a Trasitional IRA ?
Each fund that is open to IRA investors sets its own initial minimum investment. Some are as low as $100 and some as high as $3,000. You can find out what the initial minimum investment is by looking at the fund’s website.
Can you explain what my broker calls an “indirect rollover”, that allows me to withdraw funds from my traditional IRA with no penalty or tax liability so long as I return the funds within 60 days…? We need a short-term ‘bridge loan’ for a home purchase as the funds we would use are coming in just a month too late… this could do the trick.
If you withdraw money from your IRA and roll it over into another IRA or return it to the original IRA within 60 days of taking the money out, there is no penalty. So, yes, you can use your IRA funds for a bridge loan without suffering any tax consequences, as long as the money is back into your IRA within 60 days. However, because of the significant potential penalties, talk with the company where your Traditional IRA resides, before taking this step.
I’m 58 years old. If I rollover my pension lump sum and 401k to an IRA, will I have to wait 5 years before I can withdraw from it? Or can I live on it right away?
If I was to die can my spouse receive the ROTH IRA?
Alex – Yes, if you name your wife as your beneficiary, she will receive your Roth IRA and not have to pay any taxes on it.
Tom – You can withdraw money from your 401k rollover to an IRA at any time. However, if you do so before you turn 59 1/2 you may have to pay a penalty. I don’t know how soon you can take out your pension without penalty. Contact your plan administrator.
I’m 65 and want to contribute to a new traditional IRA before the April 17, 2012 deadline for 2011 transactions. If I should need any or all of the funds, lets say in 6 months, would I be subject to some kind of penalty because I withdrew funds before the end of the year. Contribution will be the max for myself as well as one spousal IRA. ($12,000 total)
Thanks, Mike
You can withdraw contributions from an IRA after age 59 1/2 and not pay any penalties. So, you can contribute to your 2011 IRA now and withdraw it in early 2012 without penalty.
I am over 701/2 but my wife is 67. We file jointly on the lower end of $50,000. She has no earned income,but I do. Since we file jointly can she still qualify for an IRA?
I put $3500.00 into my individual Traditional IRA for 2011. I also contributed $6578 to my SIMPLE IRA at my job. Am I over contributed?!! I am 50 years old.
You can’t contribute more than $6,000 a year into a Traditional IRA and more than $14,000 into a SIMPLE IRA (you are age 50 or older). You can contribute to both in one year. Check with your employer to make sure you have these two different IRA accounts. If so, you are fine.
Jack – Since you are filing a joint return, your spouse can contribute to her own IRA. She doesn’t need to have her own earned income.
I have an IRA in a Scottrade account…can I move 5000 into another investment…and how is this documented that the money is designated to stay as an IRA ?
You can move money from one IRA to another IRA. When you invest the money in another IRA, you will fill out paperwork for that investment which will identify the investment as an IRA.
i read somewhere that a roth ira is insured up to $250,000 by FDIC so shouldnt one be scared to start investing at age 25 and take a chance of loosing it all if their bank was to go under?
You can invest in a Roth IRA through a bank that insures deposits of up to $250,000 per person. Actually, you can insure more than $250,000 if you have different accounts. However, the investments that can be insured through the Federal Deposit Insurance Corporation (FDIC) are fairly limited: money market accounts, savings accounts, and certificates of deposit (CDs). You cannot invest in stocks, bonds or mutual funds and be insured through the FDIC.
If you are scared that you might lose your investments, then you need educate yourself more about investing. At age 25 you have many, many years to invest and have your investments overcome down years. Unless you do invest in riskier investments such as stocks, bonds, and mutual funds, you will have little chance that your investments will exceed the rate of inflation and generate enough income to live on in retirement.
Ideally, you want a balance of investments in equities (stocks, real estate) and fixed income (bonds, CDs).
Are there limits on the types of investments that I could put my IRA into?
Futeres? FOREX? commodities?
There are very few limits of what you can invest within an IRA. You can invest in futures, forex and commodities within an IRA. You cannot invest in collectibles: artwork, rugs, antiques, metals, gems, stamps, coins, or alcoholic beverages.
I am 73 years old and required to withdraw minimum distribution amount from my IRA accounts,which I do. Since I am working full time, can I still contribute in my IRA account? Further can I contribute into my wife’s IRA account, who is 69 years old but is disabled and has no income. Can I put $6000.00 into the IRA account for each of us? That way we do not have to
pay taxes on $12000.00 this year.Please let us know if this is allowed.
Thanks.
After you reach age 70 1/2 you can no longer make contributions to a traditional IRA for yourself. You can make an IRA contribution for your wife, because she has not reached that age yet. You could also make contributions to a Roth IRA (under your name and/or your wife’s name) as long as you are working and meet the income eligibility guidelines.
I want to start an IRA and take the tax credit for contributions this year. I just noticed that my w2 states “retirement plan” . I do not have a 401K there or other plan there so I am not sure what the retirement plan consists of(it was news to me but I have been there less than 1 year). I am over 50.
Will I be able to start an IRA before filing my taxes?
Does it reduce my taxable income thereby the taxes due by the amount contribute(ex $6K contributed to an IRA would reduce the taxes owed by 6K?)
Thanks
Ask your employer about the retirement plan you have at work. If you are income eligible, you can still contribute to a separate IRA on your own. For 2011, if you are single and your modified AGI is less than $66,000 you can make a contribution. If you are married, your family’s AGI must be less than $110,000 to qualify.
A contribution to your individual IRA would not decrease your taxes by every dollar of contributions. The amount of tax savings depends on your tax bracket. So, if you were in the lowest 10% tax bracket, a $1,000 IRA contribution would reduce your taxes by $100. If you were in the 25% tax bracket, a $1,000 contribution would reduce your taxes by $250.
for 2011 i was covered by a 401k at work and contributed the max. i am 62. my wife who is 65 made $3,000 but our agi was $153,560 from all income sources and we are filing jointly.we know we can put all of her wage in a ira, but it seems that we might be able to contribute and deduct $6k for her.i read the irs rules but i am still unsure. can we go to the $6,000? we do our own taxes. your answers are helping all of us. thank you.
The maximum you can make to be eligible to contribute to an IRA is $110,000 AGI. Since you make more than this, your wife can’t contribute to a Traditional IRA. Since you make less than $169,000 your wife is eligible to contribute to a Roth IRA. She can contribute $6,000 to a Roth since together you earned more than $6,000.
I am 59 1/2 and retired 3 years ago. My only source of income is my pension. Am I allowed to contribute the maximum $5,000.00 to a traditional IRA even though my earnings are only from my pension?
I am retired, age 60, and have oil royalty income which I live on. Because it is unearned income i understand that I can not contribute to an IRA. However, I also have an old Sub-s corp which my wife and I are the only shareholders. It makes about 15,000 of earned income and another 3000 of unearned income each year. Can I contribute to an Ira for her or myself. There are no employees in the sub-s just the two shareholders.
If I sell my current house, and later on buy one. Do I qualify for the first time home buyer?
The first-time homebuyer credit expired as of September 2010 for everyone except for members of the “uniformed services or Foreign Service or an employee of the intelligence community…” See the Instructions to IRS Form 5405.
Joe J – Since you do have earned income ($15,000) you and your wife can contribute to your own IRA as long as you file jointly.
I lost my job last year and decided to go back to school. My 401k was rolled into an IRA and from there I cashed it out slowly to pay for school and housing expenses. This year I am being penalized the 10% on the amount not used for school. Can I make a contribution to an IRA now for tax year 2011 and take it out after a few days to claim it as income for next year? Is there a minimum amount of time that it has to remain open? Also does I only made about $3300 in wages last year, is that the limit that I can contribute? Or does it count as me putting part of my IRA back even though it is 6 months later?
I forgot to mention in my question about “Never Contribute To A Roth IRA” that I do have a traditional IRA as well. I have intended for some time to only make contributions to my Roth IRA now (I am 67), but in light of that article I want to make sure that only contributing to my Roth is really my best option.
Tom, Thank you for a very informative article. I have a question: I am self employed, I don;t make a lot of money but managed to contribute $2000-3000 to my IRA for the past few years. Last year, I anticipated getting a big contract that was going to boost my income considerably, so I decided to open an individual 401K account. I made a total of $10,000 contributions to the new 401K, I also $150 automatically go to my existing IRA account- for a total of $1800 for 2011. Sadly, the big contract didn’t come through… I use TurboTax to do my taxes, and having a hard time getting a straight answer about what is allowed. According to TurboTax, given my “net income of $7785″ I am only allowed to claim $7235 of my 401K and nothing to my IRA…. My question is: Can I still keep the contributions I made to the two accounts in the accounts, and just not deduct them from my taxes- if so, do I claim them on my tax forms somehow? Or do I need to take the money out of the accounts before April 15th… to avoid some penalty?
thank you!
If i am allowed to contribute $6000 to an IRA, can I contribute $6000 to a Roth and $6000 to a traditional IRA for the year or is it a $6000 combined total of the 2 accounts?
Is it true that I can not inherit a traditional or simple IRA unless I am actually named as a beneficiary? I was declared a beneficiary of a residual estate which contains an IRA, but was told by the personal rep. that the IRA can only be distributed as a cash payment.
Sharon – The total amount you can contribute to a Roth and Traditional IRA in one year is $6,000. Not $6,000 per account. So, you can contribute $2,000 to a Roth and $4,000 to a Traditional IRA in the same year, but not $6,000 to a Roth and $1,000 to a Traditional IRA in the same year.
my employer has a 401k, I do not participate with it. can i still contribute to a ira?
If I move funds from a traditional IRA to a Roth and get to tax time the following year and realize that might have been a mistake, i.e. way too many taxes, can I move it back to a traditional IRA? How long do I have to move it back and do I have to move the same 100 shares of XYZ or the dollar value?
If I have no job but, wife works and we file a joint return am I eligible for an IRA. I am on SS.
I fully funded my traditional 2011 IRA in August 2011 $6000.00. I did my taxes and found out that I only need a portion of the IRA to be deductable. How do I go about getting back the portion I wond get a tax advantage for?
I’m retired and receiving Railroad Retirement and looking into taking a position in a nonprofit that will pay me $19200 per year.
Question: Railroad Retirement will not allow me to make over $14,700 without penalty. Can I put the difference of $4500 from the $19200 into an IRA so my IRS 1099 at the end of the year shows me under the $14,700.
I do understand that when I take funds from the IRA I will pay taxes on the amount withdrawn.
If the only income is from 1099-R and Social Security can you reduce your income with an IRA if your earned income is zero. I am showing on my tax software that because the earned income is zero that getting a IRA actually increases my tax liablity.
I am married – 68 years old – wife – 66 – both retired. We both collect Social Security. I have no pension or 401 from employers. My wife has a 401 has not made any withdraws. I have a self directed individual IRA and have maded withdraws. Can I and or my wife still make IRA contributions for 2011?
My wife inherited a good size ira 3 years ago. She recently filed for a no fault divorce. Am I entitled to any of it as a marital asset? Can she withdraw money and turn it over to me as part of our settlement? She is only 39.
i am 62 when i withdraw my ira am i taxed on the gain or the entire amount
Tom, I’m hoping there is a simple answer! My mother didn’t take the RMD from one of her IRAs because distributions from other IRAs (including Dad’s IRAs) are enough to cover. My question is, can she count excess distributions (ie, over and above the RMD) from Dad’s IRAs to cover the RMD for her IRA? Thanks in advance.
Does the rule regarding age 59.5 apply to the tax year, or the actual birthdate?
I turned 59 this past February, and was hoping that I could take some money out now. Do I have to wait until August?
I am 58 years old and was recently down-sized. Based on my age and years of service I am eligible for a lump-sum distribution from a company pension plan. Can I roll-over this amount to a Traditional IRA and then begin withdrawals once I reach 59 1/2 or is there an better alternative?
I have an IRA, I am 63, am I allowed to withdraw $10,000 and invest in a friends small business that will sell me a 10% note