- The government established IRAs in 1974 to provide personal savings plans for those without a traditional pension plan to save for retirement while also enjoying some tax benefits. Depending on your income, you may be able to contribute to an IRA without paying taxes on the earnings until the account distributes the funds to you in the future.
- To contribute to a traditional IRA, you must have earned income during the year. Earned income, under the Internal Revenue Service (IRS) definition, include wages, salaries, commissions and tips. The tax laws also consider any alimony and separate maintenance payments that you receive as earned income for purposes of IRA contributions and calculations.
However, rental income, dividends, interest and capital gains are not earned income. So if your only source income is from these, you cannot contribute to an IRA. - You may contribute up to $5,000 to an IRA if you are under age 50, and up to $6,000 if you are age 50 or over. However, you can contribute no more than your earned income. For example, if you have earned income of $2,500 and $5,000 in dividend income, you can contribute no more than $2,500.
Your income may also limit the tax deduction for your IRA contribution. If you have a a retirement plan at work, the tax law phases out your IRA deduction if you earn $56,000 but less than $66,000 for a single individual (or head of household); more than $89,000 but less than $109,000 for a married couple filing a joint return (or a qualifying widow(er), and if you earn less than $10,000 and are married filing separately. You may still make nondeductible contributions to your IRA. - You may contribute to an IRA up to the year in which you turn 70 1/2. You may start withdrawing funds without penalty when you turn 591/2. You may also withdraw funds without penalty for certain medical and educational expenses, or if the distributions are in the form of an annuity. You must start taking required minimum distributions in the year you turn 70 1/2.
- The Roth IRA was introduced in 1998. Named after its chief sponsor, Sen. William Roth (R-Del.), the Roth IRA has most of the same rules as a traditional IRA, The major exception is that contributions to a Roth IRA are not deductible on your tax return when you make them. However, the withdrawals from a Roth IRA are not taxed, either. So many financial planners recommend a Roth over a traditional IRA. You may convert a traditional IRA to a Roth but will have to taxes on any funds that you convert. The theory is that you deducted these contributions in earlier years, so you should pay taxes on them now. Any converted funds can be withdrawn tax-free once distribution starts.
- The limitations for IRA contributions increase frequently as Congress looks for ways to help people fund their retirements. So it is important to keep abreast of changes as they occur so that you can maximize the funds you have available to augment any Social Security income you will receive and any non-IRA savings you have for retirement.