Note: The article below refers to the 2017 tax year. Assuming your IRA account was opened by Dec. 31, 2017 you have until the tax-filing deadline—April 17, 2018—to make a 2017 contribution. The income/contribution limits may increase for the 2018 tax year.

Quick Summary

  • 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.

Introduction

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 have a lot of investment options 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:

Different Types of IRAs

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 which account is best for you, read more about the difference between a Traditional IRA and a Roth IRA.

We will focus on Traditional IRAs in 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. These are set up by an employer or by someone who is self-employed.

Eligibility Rules

Anyone can open an IRA, but you can’t always take a tax deduction for your contributions. However, you must contribute from “taxable compensation,” as defined by the IRS.

What counts as taxable compensation: wages and salaries, commissions, self-employment income, alimony and separate maintenance, and nontaxable combat pay.

What doesn’t count? Earnings and profits from property, interest and dividend income, pension or annuity income, deferred compensation, income from certain partnerships and “any amounts you exclude from income.”

IRA Contribution Limits

For 2017, the contribution limit is $5,500—$6,500 if you are age 50 or over. This covers your total contribution to either a Traditional or a Roth IRA.

If you accidentally contribute too much to your account(s), take it out again. But until you do, you’ll owe a 6% tax on the excess.

The only exception: Income that you rollover from another IRA, 401(k) or other approved retirement plan into an IRA does not come under this limitation.

IRA Tax Deduction Limits

How much of your Traditional IRA contribution you can deduct depends on whether you are covered by a retirement plan, such as a 401(k), at work. If you (or you and your spouse) aren’t covered at work, you can deduct your entire annual IRA contribution. If either of you has an at-work retirement plan, income limitations determine whether you can take a full deduction, a partial deduction or no deduction.

The limits are determined by your tax filing status and your income, or MAGI. See the table below for more details.

IRA Eligibility and Contribution Rules, Combined

You can use this chart to see whether you are eligible to make a tax-deductible contribution, and how much your contribution limit is. (Remember, if neither you nor your spouse has a plan at work, you can take a full tax deduction for your contributions to a Traditional IRA.)

Tax Filing Status Modified AGI or “MAGI*” Eligible Deduction
Single or head of household, with a plan at work $62,000 or less $5,500 ($6,500 for those 50 and older).
More than $62,000 but less than $72,000 partial deduction
$72,000 or more no deduction
Married filing jointly or separately: You are covered by a plan at work. Or qualifying widow(er) with plan at work $99,000 or less $5,500 ($6,500 for those 50 and older).
more than $99,000 and less than $119,000 partial deduction
$119,000 or more no deduction
Married filing jointly: You have no plan at work/your spouse is covered by a plan at work $186,000 or less $5,500 ($6,500 for those 50 and older).
More than $186,000 but less than $196,000 partial deduction
$196,000 or more no deduction
Married filing separately whether your spouse has a plan at work or not [if you lived with spouse] less than $10,000 partial deduction
$10,000 or more no deduction

Rules on Investments

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 gold using IRA funds in a self-directed IRA.

IRA Withdrawal Rules

There are many complicated rules about 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 at 70½.

Early Distributions

If you want to withdraw money from your IRA before 59½, your withdrawal will be taxed at your regular tax rate, and may incur an additional 10% early-withdrawal penalty. 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.

Required Minimum Distributions

After you are 70½, 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 developed by the IRS, based on your life expectancy. You can learn how to calculate your required minimum distribution by starting here on the IRS’s website.

Many people seek the help of an accountant or financial advisor to calculate 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.

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