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Individual Retirement Accounts - Traditional IRAs

Jan 01, 2023

What is an IRA?

An IRA is an individual retirement arrangement. It is a personal savings plan that gives you tax advantages for setting aside money for retirement. An IRA is referred to as a traditional IRA if it is not a Roth IRA or a SIMPLE IRA. Traditional IRAs include SEP IRAs.

Traditional IRA tax advantages and rules:

  • Contributions to an IRA may be fully or partially deductible.
  • Amounts in your IRA (including earnings and gains) are not taxed until distributed.
  • There is no limit on how much you can earn and still contribute (however, contributions are not deductible above certain amounts).
  • There is no age limit for contributions.
  • Required minimum distributions begin after age 73.
  • Early distributions (before you are age 59 1⁄2) are subject to a 10% additional tax. Exceptions apply.
  • Distributions are taxed as ordinary income.

Who Can Contribute to an IRA?

Any individual can set up a traditional IRA if he or she receives taxable compensation during the year. An individual can have a traditional IRA even if covered by an employer-sponsored retirement plan. However, the deductible amount of contributions to a traditional IRA may be phased out. See Reduced IRA Deduction, next page.

Contribution limit. Contributions to IRAs are limited to the lesser of the individual’s compensation (or spouse’s compensation under a spousal IRA), or $6,500 ($7,500 for age 50 or older).

Total contributions are combined with Roth IRA contributions to determine limits. For example, a $1,000 contribution to a Roth IRA will reduce total contributions allowable to a traditional IRA by $1,000.

Spousal IRA. If both spouses have compensation, each can set up a separate IRA. Spouses cannot participate in the same IRA. However, if MFJ, and one spouse’s compensation is less than the contribution limit, the lower-income spouse can use the compensation of the other spouse to qualify as only one spouse needs to have compensation.

Example: Jill is a full-time student under age 50 with no taxable compensation. Her husband, Barry, is under age 50 and has taxable compensation of $30,000. If they file a joint return, both Barry and Jill can each contribute $6,500 in 2023 to their own IRAs.

Excess contributions. If contributions to your IRA exceed the annual limit and the excess contributions are not withdrawn by the due date of your return (including extensions), you are subject to a 6% excise tax for each year the excess amounts remain in your IRA.

When Can You Make Contributions?

Contributions to an IRA can be made at any time during the year or by the due date of your return for that year (not including extensions). This means that most people can make contributions for 2023 by April 15, 2024.

How Much Can You Deduct?

Generally, you can deduct the lesser of:

  • The contributions to your traditional IRA for the year, or
  • The general limit (or spousal limit) for the year.

However, if you or your spouse is covered by an employer retirement plan, you may not be able to deduct this amount.

Covered by an employer retirement plan. If you or your spouse was covered by an employer retirement plan at any time during the year for which contributions were made, your deduction may be limited. Limits on the amount you can deduct do not affect the amount that can be contributed. Box 13, Form W-2, will be checked if you are covered.

Reduced IRA Deduction

Subject to whether you or your spouse was covered by an employer retirement plan, you may be entitled to only a reduced (partial) deduction or no deduction at all, depending on your modified adjusted gross income (MAGI) and filing status.

MAGI. MAGI for IRA purposes is your adjusted gross income (AGI) plus any traditional IRA deduction, student loan interest deduction, foreign earned income or housing exclusion, U.S. Savings Bond interest exclusion, or employer-provided adoption benefits exclusion.

Required Minimum Distribution (RMD)

The RMD is the minimum amount that you must withdraw each year upon reaching age 73. You may withdraw more than the minimum required amount. The withdrawals will be included in taxable income except for any part that was already taxed or can be received tax free.

 

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