IRA Basics
What is an IRA?
An IRA is an individual retirement arrangement, which can be an individual retirement account or an individual retirement annuity. It is a personal savings plan that allows you to set aside money for retirement with tax advantages. There are two primary types of IRAs: Traditional and Roth. Depending on which one you choose, you may be able to deduct some or all of your contributions. You also may be eligible for a tax credit equal to a percentage of your contribution.
How does a Traditional IRA differ from a Roth IRA?
With a Traditional IRA, assuming you’re eligible, your contributions are tax-deductible. Your earnings grow tax-deferred, so you will not pay income taxes on your investment earnings until you make withdrawals. Both deductible contributions and earnings are then taxed at your regular income tax rate when the money is withdrawn.Contributions you make to a Roth IRA are never tax-deductible, so they will always be tax-free upon distribution. Your earnings grow tax-deferred, so you will not pay income taxes on your investment earnings until you make withdrawals. And if you take a “qualified distribution,” your earnings are tax-free.
Why should I name beneficiaries for my IRA?
When you open an IRA, you may be asked to designate primary and contingent beneficiaries. These are the people (or entities) who will receive your IRA assets if you die before you’ve withdrawn all your money. If you have significant assets or special concerns, you may want to consider consulting a tax advisor or estate planning professional to help ensure that your IRA is distributed according to your wishes and in the most tax-advantaged way allowed.
What investments can I use for my IRA?
Technically, an IRA is a tax-advantaged personal savings arrangement set up as a trust or custodial account that holds your investments. You can establish an IRA at any credit union, bank, other financial organization, brokerage firm, or mutual fund company. You also may establish an individual retirement annuity with an insurance company. Subject to what is allowed by the financial organization, you may invest your IRA money in most types of savings and investments, including CDs/share certificates, share savings, mutual funds, and individual stocks and bonds. You cannot invest in life insurance or collectibles, including artwork, stamps, antiques, and some coins.
Can anyone contribute to an IRA?
You are eligible to contribute to a Traditional IRA if you are under age 70½ and you have eligible compensation. For IRA purposes, eligible compensation generally is defined as the money you earn from working and includes wages, salary, tips, bonuses, commissions, and self-employment income, but not investment or pension income. If you are a non-earning spouse under the age of 70½ who files a joint tax return with a working spouse, you also are eligible to contribute to a Traditional IRA.You can contribute to a Roth IRA if you have eligible compensation below or within the modified adjusted gross income (MAGI)* limits. Unlike the Traditional IRA, there is no age restriction; you can contribute to a Roth IRA even after turning age 70½. If you are single, you can contribute to a Roth IRA for 2017 if your MAGI*is no greater than $133,000 ($132,000 for 2016). If you are married, filing jointly, you can contribute to a Roth IRA for 2017 if your joint MAGI* is not greater than $196,000 ($194,000 for 2016). *Modified adjusted gross income (MAGI) is your adjusted gross income from your IRS federal Form 1040 or 1040A tax return with the following added back: any Traditional IRA deduction, foreign earned income exclusion, student loan interest deduction, tuition and fees deduction, foreign housing deduction or exclusion, U.S. savings bond interest exclusion, domestic production activities deduction, or adoption expenses. For Roth IRA purposes, MAGI also excludes any income reported from the conversion of a Traditional IRA to a Roth IRA.
How much can I contribute to my IRA?
You can contribute up to $5,500 for 2016 and 2017 to an IRA, provided you earn at least that amount in compensation. If you are age 50 and older before the end of the year, you can make an additional $1,000 catch-up contribution, for a total of $6,500 for 2016 and 2017.Keep in mind that your annual contributions cannot exceed your annual compensation. In addition, any contributions you make to one IRA type (Traditional and Roth IRAs) will reduce contributions you can make to another type of IRA. In other words, for 2017 you can contribute a combined total of up to $5,500 ($6,500 with catch-up) to both Traditional and Roth IRAs. If you have little or no compensation, but are married and your spouse has eligible compensation, you are eligible to contribute up to the annual individual limit to your own IRA, as long as you file a joint tax return and there is enough income to support both you and your spouse’s contributions. It is important to note that you and your spouse cannot jointly own an IRA. Excess contributions If you contribute more than the allowable amount for a given tax year (excess contribution) to your IRA or make an improper rollover (which are deemed to be regular contributions), you must withdraw the excess along with any earnings by the due date of your tax return, including extensions. If you don’t, you’ll owe a six percent penalty tax that will be assessed each year on any excess amount that remains in your account.
When can I make my IRA contributions?
You can contribute to your IRA anytime during the current year for that particular tax year. In fact, you can make contributions up until the due date for filing your tax return for that tax year, not including extensions. For most people that date is April 15. For example, you can make your 2016 tax year contribution anytime between January 1, 2016, and April 15, 2017. And you can make your 2017 tax year contribution any time between January 1, 2017, and April 15, 2018. You can make your annual contribution to your IRA all at once or divide it into smaller amounts on your own schedule, subject to your IRA administrator’s minimum requirements. You do not have to contribute to your IRA every year, nor do you need to make the maximum allowable annual contribution. If you do contribute less than the maximum in any given year, you cannot make up the shortfall in a later year.
Which one is best for me if I qualify for both a Traditional and a Roth IRA?
When you are eligible to contribute to a Roth IRA and make tax-deductible contributions to a Traditional IRA, the decision of which one to contribute to often comes down to whether you’d rather receive a tax break up front (Traditional IRA tax deduction) or later (tax-free Roth IRA distribution).Assuming you contribute the same amount to each type of IRA, it may come down to what you do with the money you save in taxes by making tax-deductible contributions to a Traditional IRA. Would you save the annual tax savings each year and invest it for retirement? Or would you spend it? If you do not invest the tax savings, a Roth IRA may provide more money after taxes at retirement. If you spent or did not invest the tax savings, it’s not available to add to your retirement fund. You may be giving up a tax break today when you make Roth IRA contributions, but the payoff may be a larger retirement fund down the road. If you invest the tax savings, your decision may be based on whether you think your tax bracket in retirement will increase, stay the same, fall slightly, or significantly decrease. If you think your income tax bracket during retirement will significantly decrease, you generally may pay less taxes on the Traditional IRA savings distributed during retirement than you would pay now on the income used to make Roth IRA contributions. In this scenario, you would shelter your current income from a higher tax rate by making tax-deductible Traditional IRA contributions and take your IRA withdrawals during retirement-when you’re in a lower tax bracket. But if you are not retiring soon, a Roth IRA’s advantage of tax-free earnings and more flexible withdrawal rules may outweigh the tax savings from deductible contributions today. If you think your income tax bracket will be the same or higher during retirement, paying taxes on the income for Roth IRA contributions now, with the potential for tax-free earnings, may be a good option. No one can predict the tax rates in the future, so make sure you seek competent tax or financial planning advice if you’re unsure which route is best for you.
What are some issues to consider before contributing to a Roth IRA?
You may want to consider contributing to a Roth IRA if you are not eligible to make tax-deductible contributions to a Traditional IRA, but you are eligible to contribute to a Roth IRA. Earnings in a Roth IRA accumulate tax-free and also can be distributed tax-free if qualified. Roth IRAs also have more flexible early distribution rules than Traditional IRAs. You can take tax-free and penalty-free distributions up to the total amount of your annual contributions—at any time and for any reason. In addition, you are not required to begin taking mandatory distributions at age 70½ from a Roth IRA like you are with a Traditional IRA, so your savings can potentially accumulate tax-free much longer and you can take your money out on your own time.
What are some things to consider before making nondeductible contributions to a Traditional IRA?
If you are not eligible to contribute to a Roth IRA or make tax-deductible contributions to a Traditional IRA, you can still make nondeductible contributions to a Traditional IRA (as long as you have eligible compensation).Making nondeductible contributions to a Traditional IRA may be right for you if retirement is still several years away and you want to defer taxes on investments that would be subject to ordinary income taxes, such as mutual funds and stocks, if not contributed to a tax-deferred savings vehicle.
Do I need an IRA if I have an employer-sponsored qualified retirement plan (QRP)?
If you are participating in an employer-sponsored retirement plan, such as a 401(k), tax-sheltered annuity 403(b), or a governmental 457(b) plan, ideally you should contribute the maximum to both your plan and an IRA. But saving that much may not be realistic for many people. Specifically for 2017, you generally can defer up to $18,000 of your wages into your employer’s retirement plan, plus an extra $6,000 catch-up contribution if you’re age 50 or older ($18,000 for 2016, plus $6,000 in catch-up contributions). Meanwhile, the IRA maximum annual contribution for 2016 and 2017 is $5,500, plus an extra $1,000 catch-up contribution if you are eligible. You can contribute to IRAs and a retirement plan for the same year, but your eligibility to deduct a Traditional IRA contribution may be affected by your participation in a retirement plan.If your employer matches a percentage of your retirement plan contributions, many advisors recommend that you contribute at least enough to earn the full amount of the match before contributing to an IRA. But if you want investment options that are not available in your employer’s retirement plan, saving in an IRA may give you different investment options. IRAs also offer more flexible withdrawal provisions, allowing you to access your money any time you need to, subject to potential taxes and penalties; retirement plan distributions only are allowed upon certain “triggering” events.
Am I eligible to receive the Saver’s Tax Credit for my IRA contribution?
Low- to moderate-income workers may be eligible for an income tax credit when saving for retirement. This credit reduces the federal income tax you owe dollar-for-dollar and is over and above any deduction or exclusion you may be entitled to for your retirement contributions.You are eligible for this credit if you meet the income limits and if you contribute to a Traditional IRA or Roth IRA, or made salary deferrals under a 401(k) plan, 403(b) plan, governmental 457(b) plan, federal Thrift Savings Plan, SEP plan, SIMPLE IRA plan, or SIMPLE 401(k) plan. You also must be at least 18 years old and not a full-time student or claimed as a dependent on another taxpayer’s return. You must file IRA Form 8880, Credit for Qualified Retirement Savings Contributions, with your income tax return to claim the credit. EXAMPLE: Let’s say you qualify for the maximum 50% credit and you contribute $2,500 in 2017 to an eligible retirement plan or IRA. You will reduce your tax bill by $1,000 in 2017 (50% of the first $2,000).
| Saver’s Tax Credit for 2016 | |||
| Applicable Percentage | Joint Return | Head Of Household | All Other Cases* |
| 50% | Up to $37,000 | Up to $27,750 | Up to $18,500 |
| 20% | $37,000–$40,000 | $27,750–$30,000 | $18,500–$20,000 |
| 10% | $40,000–$61,500 | $30,000–$46,125 | $20,000–$30,750 |
| 0% | Over $61,500 | Over $46,125 | Over $30,750 |
| Saver’s Tax Credit for 2017 | |||
| Applicable Percentage | Joint Return | Head Of Household | All Other Cases* |
| 50% | Up to $37,000 | Up to $27,750 | Up to $18,500 |
| 20% | $37,000–$40,000 | $27,750–$30,000 | $18,500–$20,000 |
| 10% | $40,000–$62,000 | $30,000–$46,500 | $20,000–$31,000 |
| 0% | Over $62,000 | Over $46,500 | Over $31,000 |
*Includes single filers, married filing separately, and qualifying widow or widower.
When can I withdraw money from my IRA?
You can withdraw money from your IRA at any time, but the IRS generally assesses a 10 percent early distribution penalty tax on the taxable portion of any withdrawals you make before turning age 59½. This penalty tax is in addition to the income tax you’ll owe on your earnings and on any deductible contributions you made.
What types of early distributions are not subject to the 10 percent penalty tax?
You can make tax-free and penalty-free early distributions from a Roth IRA up to the total amount of your annual contributions—at any time and for any reason. But the earnings will be subject to tax and a 10 percent penalty tax unless you qualify for a penalty tax exception. The pretax portion of Traditional IRA distributions are subject to income tax and the 10 percent penalty tax unless a penalty tax exception applies. There are several ways you can avoid the 10 percent early distribution penalty tax on IRA distributions. The penalty tax does not apply if your distribution is taken for any of the following reasons (subject to certain restrictions).
- Payments to beneficiaries after an IRA owner’s death
- Disability (permanently disabled under the IRS definition)
- First-time homebuyer expenses
- Unreimbursed medical expenses that exceed a certain amount of income
- Health insurance premiums during unemployment
- Qualified higher education expenses
- IRS levy
- Substantially equal periodic payments
- Qualified reservist distributions
Can I move money between IRAs?
You can move money from one IRA to another IRA of the same type as a transfer or a rollover. The transaction is tax-free if it is properly done. Changing investments within your IRA does not constitute a transfer or rollover.Transfer To move the money between your IRAs using a transfer, instruct your financial organization to move the money directly to an IRA you’ve established with another financial organization. The money in your account never actually passes through your hands. You can transfer all of the money in your IRA or only a portion, as many times as you want. Rollover To move the money in your IRA using a rollover, your financial organization distributes the amount of money you choose from your IRA to you. Even if you plan to roll over the assets, the distribution still is subject to federal withholding, unless you elect to waive withholding. Once you receive the money, you have 60 days to roll over the money to an IRA to avoid paying tax on it. If you miss the 60-day deadline, you cannot put the money back into an IRA. If you took a distribution from a Traditional IRA, you will be subject to federal income taxes (excluding nondeductible contributions) and a 10 percent early distribution penalty tax if you are younger than age 59½ and you do not qualify for a penalty tax exception. If you miss the 60-day deadline on a Roth-to-Roth IRA rollover, you may be taxed and penalized on any amount that exceeds the contributions you’ve made to your Roth IRA.
What are my options if I inherit an IRA?
The options available to you as a beneficiary will depend on what the IRA plan agreement dictates. Even then, a number of factors will affect your choices, such as the type of IRA, the number of beneficiaries, whether or not you are the spouse of the IRA owner, and sometimes, the IRA owner’s age at death.If you’ve inherited a Traditional IRA, what you can do with the IRA will first depend on the IRA owner’s age at the time of death. More specifically, did the IRA owner die before or after his required beginning date (RBD) for required minimum distributions? The RBD is the date that Traditional IRA owners must start taking annual distributions from their IRAs. The RBD is April 1 of the year following the year the IRA owner turns 70½. For example, if the IRA owner reached age 70½ in November 2016 (he turned 70 in May 2016), his 70½ year is 2016. Thus, his RBD is April 1, 2017. Federal law allows the following beneficiary distribution options, but check with your financial organization to see if all these options are available to you. If the IRA owner died before his RBD, you generally may have the choice of
- taking a lump-sum distribution, meaning you will have immediate access to the money but lose the tax-deferred benefits;
- taking annual distributions of at least a required minimum amount based on life expectancy; or
- taking distributions according to the five-year rule, meaning you can take out as much—or as little—as you want over the course of five years, as long as the IRA is totally depleted by December 31 of the year containing the fifth anniversary of the IRA owner’s death.
If the IRA owner died on or after his RBD, you generally may have the same choices as above except for the five-year rule. In either case, if you are a spouse beneficiary, you have the added option to transfer or roll over the inherited assets to your own IRA. (For this option, separate accounting must be established if you are one of multiple beneficiaries.) Please take note that this is only available to spouse beneficiaries. If you’ve inherited a Roth IRA, you may have the same options that are available for Traditional IRAs when the IRA owner dies before her RBD. Roth IRA owners do not have RBDs; they are never required to take annual distributions. So, Roth IRA beneficiaries may have all these distribution options available to them regardless of when the IRA owner died. And as with Traditional IRAs, the options depend on whether you are a spouse or nonspouse beneficiary. Inherited IRA assets that you withdraw are subject to income tax rules. Pretax assets distributed from Traditional IRAs and nonqualified assets from Roth IRAs (when the IRA owner did not reach a five-year holding period) generally are taxable, but the 10 percent early distribution penalty tax does not apply because death is a penalty tax exception. Depending on your specific financial situation and if the distribution is a significant amount, this could result in major tax consequences. Understanding your options and deadlines as a beneficiary is important because decisions you make now may be irrevocable down the road.
FAQs are not intended to provide tax advice. Contact a tax professional.
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