Note: The article below refers to the 2016 tax year. Assuming your IRA was opened by Dec. 31, 2016 you have until the tax-filing deadline–April 18, 2017–to make a 2016 contribution. The income/contribution limits may increase for the 2017 tax year.
- An IRA is a special savings account for retirement. In most cases, you get a tax break on money you put into an IRA.
- There are multiple types of IRAs, but Traditional IRAs and Roth IRAs are the most common.
- There are special rules for who is eligible for each type of IRA.
An IRA is an Individual Retirement Account and the nice thing is that almost anyone can start an IRA. Once you start an IRA, you can invest in an amazing variety of products from stocks, bonds and mutual funds to more complicated investments.
What makes IRAs beneficial are the tax advantages that come along with them. Different types of IRA have different tax benefits and different rules:
- What are the different types of IRAs?
- Are you eligible to open a Traditional IRA?
- What are your contribution limits?
- How much of a tax deduction can you take?
- What can you invest in?
- Is it possible to withdraw the money early?
- When do you have to begin withdrawing the money and how much do you have to withdraw each year?
The two most common types of IRAs are Traditional IRAs and Roth IRAs. With Traditional IRAs, you are frequently able to get a tax deduction for the money that you put into the IRA. With a Roth IRA, you don’t get a tax deduction when you invest the money, but instead get to withdraw the money tax-free. If you are trying to decide between a Traditional IRA and a Roth IRA, we can help you figure out which IRA is right for you.
We will focus on Traditional IRAs on this article, but there is lots of great information on Roth IRAs at RothIRA.com.
There are also other types of IRAs such as a SEP IRA or a SIMPLE IRA, but these are set up by an employer or by someone who is self-employed.
Anyone can open an IRA, but you can only take a tax deduction for your contributions if your income is below certain limits. The limits are determined by your tax filing status and your income, or MAGI. See the table below for more details.
For 2016, the contribution limit is $5,500, or $6,500 if you are over 50.
How much of your contribution you can deduct depends on whether you are covered by a retirement plan at work. If you (or your spouse) aren’t covered at work, you can deduct your entire annual IRA contribution. If you or your spouse is covered by a retirement plan at work, your deduction may be limited (check the table below for the exact income guidelines).
If you accidentally contribute too much to your account, take it out again. But until you do, you’ll owe a 6% tax on the excess.
You can use this chart to see whether you are eligible to make a tax-deductible contribution, and how much your contribution limit is.
|Tax Filing Status||Modified AGI or “MAGI*”||Eligible Deduction|
|Single, head of household, or qualifying widow(er)||$61,000 or less||$5,500 ($6,500 for those 50 and older).|
|More than $61,000 but less than $71,000||partial deduction|
|$71,000 or more||no deduction|
|Married filing jointly or separately and your a spouse is covered by a plan at work||$98,000 or less||$5,500 ($6,500 for those 50 and older).|
|more than $98,000 and less than $118,000||partial deduction|
|$118,000 or more||no deduction|
|Married filing jointly and your spouse is not covered by a plan at work||$183,000 or less||$5,500 ($6,500 for those 50 and older).|
|More than $183,000 but less than $193,000||partial deduction|
|$193,000 or more||no deduction|
|Married filing separately with a spouse who is covered by a plan at work||less than $10,000||partial deduction|
|$10,000 or more||no deduction|
Through a Traditional IRA, you can put your money in many different kinds of investments, including stocks, bonds, mutual funds, ETFs and lifecycle funds. You can buy any investment your bank or brokerage offers in your IRA.
You cannot invest IRA funds in life insurance or collectibles. Examples of collectibles include artwork, cars and jewelry. One exception is certain kinds of gold coins, which you are permitted to invest in using IRA funds. You can find more information here.
There are many complicated rules on IRA withdrawals, also called distributions. There are two main kinds of withdrawals: early withdrawals and required withdrawals. You may start withdrawing money from your IRA at 59½ and you must start withdrawing by 70½.
If you want to withdraw money from your IRA before 59½, your withdrawal will be taxed at your regular tax rate, and may be taxed at an additional 10%. There are exceptions, however. You may be able to avoid the early withdrawal penalty for medical expenses, to purchase a first-time home purchase, for certain educational expenses or for other special situations. You can find a full list here.
After you are 70 1/2, you must start withdrawing from your IRA. Those withdrawals are called required minimum distributions (RMDs) and must be taken each year.
Your required minimum distribution is calculated by dividing your IRA account balance as of Dec. 31 the prior year by a certain number, based on your life expectancy and developed by the IRS. You can figure out how to calculate your required minimum distribution by starting here on the IRS’s web site.
Many people seek the help of an accountant or financial advisor to help figure out their required minimum distributions.
The Most Important Rule
Because of the tax deductions, IRAs are one of the most beneficial ways to invest and save for retirement.