Rules For The Traditional And Roth IRA Contributions
IRAs offer tax advantages for long-term retirement planning. The two most used types of IRAs are traditional IRAs and Roth IRAs. Earnings in these accounts can accumulate either tax-deferred or tax-free. Also, you can deduct traditional IRA contributions.
You can get a traditional IRA if you’re under age 70 1/2 and receive taxable compensation. This compensation includes:
- Wages, salaries, and tips
- Sales commissions
- Professional fees
- Self-employment income
- Military compensation while serving in a combat zone tax-exclusion area
- Alimony or separate maintenance payments included in gross income
Income not included as compensation for IRA purposes includes:
- Profit from the sale of stocks or other property
- Rental income
- Pension or annuity income
- Deferred compensation
For 2018, the maximum annual contribution is the smaller of these:
- 100% of your compensation
Ex: If you earn $2,000, then your maximum IRA contribution for the year is $2,000.
If you’re age 50 or older, you can contribute $1,000 more to your IRA. It’s considered a catch-up contribution. So, the limit is $6,500 in 2018 for those age 50 or older.
There’s no minimum age to participate in an IRA. If your teen-age child has compensation from a part-time job, your child can contribute to an IRA up to $5,500 in 2018. A one-time $5,500 investment at age 15 would grow to more than $39,000 by age 65. This assumes an average 4% annual yield.
You must begin withdrawing from your traditional IRA by April 1 the year after the year you reach age 70 1/2. Also, you can no longer contribute to your traditional IRA account in the year you reach 70 1/2.
If you’re married and one spouse doesn’t receive compensation, you can open an IRA account for the nonworking spouse. You can contribute up to $5,500 to each of your accounts in 2018. If one of you is 50 or older, the limit is $12,000 — or $5,500 for the spouse under 50 and $6,500 for the spouse over 50. When both spouses are age 50 or older, the limit is $13,000 — or $6,500 per spouse.
If your spouse is under age 70 1/2, you can continue contributing to a nonworking spouse’s account after you reach age 70 1/2.
You must file as married filing jointly to qualify for a spousal IRA.
Contributing too much
If you make excess IRA contributions, you’re subject to a 6% tax.
The penalty applies each year until you either:
- Withdraw the excess
- Use the excess as a future year’s contribution
If you withdraw the excess amount plus any related earnings before the due date, including extensions, both of these apply:
- You won’t be subject to the penalty on the excess contribution.
- You’ll pay tax on the earnings.
Due date for IRA contributions
The last day to make your IRA contribution each year is the day your return is originally due for the year, not including extensions. This is usually April 15. You can mail your IRA contribution. You’ll meet the deadline if it’s postmarked by the original due date for filing Form 1040. This doesn’t apply to the extension due date.
If your income is too high to deduct contributions to a traditional IRA, you might qualify for a Roth IRA. This might apply if you’re covered by your company’s retirement plan. However, contributions to a Roth IRA aren’t tax deductible.
You’ll still have a long-term investment in a tax-deferred retirement savings plan.
If you have contributed to a nondeductible IRA, you must keep track of your basis. By doing so, you won’t pay tax on the money again when you withdraw it.
Basis is usually the combination of these:
- Total amount of nondeductible IRA contributions you’ve made
- Basis from after-tax amounts in qualified retirement plans you’ve rolled over to your traditional IRA accounts
You must file Form 8606 for any tax year you made a nondeductible IRA contribution. You can also use Form 8606 to help you track your total IRA basis. You might have a traditional IRA with basis from nondeductible contributions or rollovers. If so, you’ll need to calculate the taxable portion of any withdrawals.
You might receive both taxable and nontaxable distributions. If so, use Publication 590 worksheets to help you figure the taxable portion of your IRA withdrawals. You’ll report the taxable and nontaxable portions of the distributions on Form 8606.
Limited IRA deductions
These two tests determine how much of your IRA contributions are deductible:
- Active participant test
- Income test
Active participant test
You’re an active participant in a company retirement plan if you put funds in a defined-contribution plan account. This is true even if your benefits weren’t vested. You’re an active participant when you contribute to one of these plans:
- Qualified pension plan
- Profit-sharing plan
- Stock-bonus plan
- 401(k) plan
- SIMPLE plan
- Simplified employee pension (SEP) plan
- Qualified annuity plan
- Retirement plan for state and federal employees, including civil service and the Federal Employees Retirement System
- Tax-sheltered annuity (403(b) plan)
Active participation is different for defined benefit plans. If you’re eligible for one of these plans for any part of the year, you’re considered covered for the whole year. A company defined benefit plan includes pension plans.
For a defined benefit plan, you’re considered to be an active participant even if you:
- Decline to participate in the plan
- Made no contributions
- Didn’t perform the minimum number of hours of service allowed to receive benefits for the year
The W-2 your employer sends you should show if you’re an active participant in an employer-sponsored plan. If you’re an active participant, the Retirement Plan box should be checked.
It might be that neither you nor your spouse were active participants in a company plan. If so, you can deduct your traditional IRA contributions regardless of how high your income is.
IRA income test
If you’re covered by a company plan, a second test decides how much of your IRA contribution you can deduct. If you’re an active participant in a company plan, the traditional IRA deduction:
- Begins to phase out when your modified adjusted gross income (AGI) reaches $61,000 — or $98,000 if married filing jointly
- Is phased out completely when your income is more than $71,000 — or $118,000 if married filing jointly. The phase-out range increases to $183,000 — or $193,000 for married couples who have only one spouse who was an active participant in a company plan.
If your modified AGI is equal to or less than the lower phase-out amount, you can deduct your full IRA contribution. This is true even if you’re an active participant in a company plan. For these purposes, your modified AGI is your AGI with these items added back:
- Traditional IRA deduction
- Student-loan interest deduction
- Tuition and fees deduction
- Foreign earned-income exclusion
- Foreign-housing exclusion or deduction
- Excluded U.S. Savings Bond interest
- Excluded employer-provided adoption benefits
- Domestic production activities deduction
If you and your spouse file separate returns, the phase-out range is $0-$10,000. So, you can’t claim the IRA deduction if your modified AGI is more than $10,000.
You’re considered unmarried for purposes of the IRA deduction limitation if you’re married but:
- You didn’t live with your spouse during the year.
- You and your spouse filed separate returns.
Roth IRAs are subject to the same rules as traditional IRAs. However, there are some exceptions:
- You must designate the account as a Roth IRA when you start the account.
- Earnings in a Roth account can be tax-free rather than tax-deferred. So, you can’t deduct contributions to a Roth IRA. However, the withdrawals you make during retirement can be tax-free. They must be qualified distributions.
- You can withdraw contributions at any time without tax or penalty.
- You can continue to make contributions after you reach age 70 1/2. However, you must still receive compensation.
- You don’t have to begin taking withdrawals at age 70 1/2.
- The balance in your account when you die goes to your heirs tax-free. The account has to have been open for at least five years.
The maximum amount you can contribute to all IRAs must be the lesser of these:
- Your taxable compensation for the year
- $5,500, the maximum IRA contribution for 2018
The amount increases to $6,500 if both of these apply:
- You’re age 50 or older.
- You’re making catch-up contributions.
However, to figure the maximum amount you can contribute to a Roth IRA for a year, you must combine the contributions you made to all IRAs. This includes both traditional and Roth IRAs. So, your contribution limit is the lesser of:
- Your maximum allowable contribution minus all IRA contributions for the year.
- Your taxable compensation minus all IRA contributions for the year.
When figuring your contribution limit, don’t subtract employer contributions under a SEP or SIMPLE IRA plan
If you contribute more than allowed to your IRA, you’ll be subject to a 6% excise tax on the excess contribution.
Who can contribute to a Roth IRA?
Higher-income people who actively participate in company retirement plans can’t deduct traditional IRA contributions. However, you can still contribute to save on a tax-deferred basis for retirement. This doesn’t apply to Roth IRA contributions.
The amount you can contribute to a Roth IRA:
- Begins to phase out when your modified AGI reaches $114,000 — or $181,000 if married filing jointly
- Is phased out completely when your income is more than $129,000 — or $191,000 if married filing jointly
These levels apply even if you’re not covered by a company pension plan.
Married couples filing separately can’t make Roth IRA contributions if both of these are true:
- Your modified AGI is more than $10,000.
- You lived together at any time during the year.
When your modified AGI is more than the maximum allowable amount, you can’t contribute to a Roth IRA. For 2018, it’s $191,000 for married filing jointly — or $129,000 for single and head of household..
Converting your traditional IRA to a Roth IRA
Before 2010, you couldn’t make a conversion if either of these applied:
- Your modified AGI was $100,000 or more.
- You filed as married filing separately.
However, the government removed the income-limit and filing-status requirements.
If you convert your traditional IRA to a Roth IRA, you usually must pay tax on the amount rolled over. However, for 2010, you must report the conversion income you received in two installments in 2011 and 2012. There’s an exception if you did both of these:
- Opted out of the two-year installment treatment
- Reported the entire conversion amount on your 2010 return
If you made a Roth conversion in 2010, you must report half of the amount. Do this on your 2011 and 2012 returns by filing Form 8606.
Nondeductible contributions you made to a traditional IRA are tax-free if you either:
- Rolled over the IRA
- Converted to a Roth IRA
Choosing your trustee
You must contribute to your IRA through a trustee or custodian the IRS approves. However, you’ll always have complete control over the investments in your IRA.
You can contribute to your IRA through any of these IRS-approved trustees:
- Bank, savings and loan, or insured credit union — Your investment is likely to be held in one of these:
- Certificates of deposit
- Money-market accounts
- Mutual-fund company — Your retirement money might be professionally managed in one of these:
- Portfolio of stocks or bonds
- Money-market fund
- Insurance company — Your money might be invested in fixed or variable annuities
- Brokerage firm — You might have a self-directed account that offers flexibility. These IRAs allow you to choose the exact types of investments you want in your IRA. You must have a self-directed account to invest in:
- Gold or silver coins
- Real estate investment trusts
- Limited partnerships
Some IRA accounts have annual fees, while others have no fees. Traditional IRA fees are a miscellaneous itemized deduction if they are both:
- Billed separately
- Not automatically deducted from your account
Your total miscellaneous deductions might be more than 2% of your AGI. If so, you can deduct these expenses.
You can have many IRA accounts. You can:
- Contribute to a single traditional IRA or Roth IRA account each year
- Open a different account each year
- Divide each year’s contribution among several accounts
- Divide your contribution between a traditional IRA and a Roth IRA
However, by having more than one account, you might also pay multiple trustee and bookkeeping fees.
No matter how many accounts you have, your total annual contributions can’t be more than the maximum allowable limit. This is $5,500 in 2018. If you’re age 50 or older, the maximum is $6,500.
Moving your money around
You don’t have to keep your IRAs in the same accounts from your contribution date to your retirement date. You can move your money around to take advantage of changes in the market or in your investment philosophy.
However, you must follow certain rules. Some financial institutions might impose early withdrawal penalties on investments (Ex: CDs and annuities). They can do this even though you roll over the investments. If you do a direct rollover, you won’t pay an IRS penalty.
Learn more about the tax rules for renting your vacation home for part of the year from the experts at H&R Block.
How does the sale of business property affect your taxes? Learn about property classifications and get tax answers at H&R Block.
What are education savings accounts, and how do they affect your taxes? Discover more about ESAs and get tax answers at H&R Block.
Learn more about mutual fund and stock dividend reinvestments from the tax experts at H&R Block.