What is a traditional IRA?
A traditional IRA is a retirement account whereby an individual can put up to $5,000 of earned income per year into the plan. While in the plan, contributions, asset growth, dividends and interest are not taxable. Monies withdrawn from the plan are generally taxed as ordinary income. There are certain penalties for early withdrawal.
Who can set up a traditional IRA?
You can set up and make contributions to a traditional IRA if you (or, if you file a joint return, your spouse) received taxable compensation during the year and you were not 70 ½ by the end of the year.
You can have a traditional IRA whether or not you are covered by any other retirement plan. However, you may not be able to deduct all of your contributions if you or your spouse is covered by an employer retirement plan.
What is compensation (earned income)?
Compensation (earned income) represents income that was actually worked for, such as wages, salaries, tips, professional fees, bonuses and self-employment income. It does not include earnings and profits from property, such as rental income, interest income and dividend income. It also does not include earnings from pensions or annuities.
When is the deadline to make a contribution to a traditional IRA?
Contributions can be made to your traditional IRA for a year at any time during the year or by the due date for filing your return for that year, not including extensions. For most people, this means that contributions for 2011 must be made by April 15, 2012.
Note: You can file your tax return claiming a traditional IRA contribution before the contribution is actually made. However, the contribution must be made by the due date of your return, not including extensions.
What is the annual contribution limit?
The most that can be contributed for any year to your traditional IRA is the smaller of the following amounts:
- Your compensation (defined above) that you must include in income for the year, or
Note: This is the most that can be contributed regardless of whether the contributions are to one or more traditional IRAs or whether all or part of the contributions are nondeductible. Contributions on your behalf to a traditional IRA reduce your limit for contributions to a Roth IRA. The total combined contributions to one or multiple IRAs cannot exceed $5,000, annually.
What are the Spousal IRA limits?
If you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your traditional IRA is the smaller of the following two amounts:
- $5,000, or
- The total compensation includable in gross income of both of you and your spouse for the year, reduced by the following two amounts.
- Your spouse’s traditional IRA contribution for the year.
- Any contributions for the year to a Roth IRA on behalf of your spouse.
Note: This means that the total combined contributions that can be made for the year to your traditional IRA and your spouse’s traditional IRA can be as much as $10,000. Contributions on your behalf to a traditional IRA reduce your limit for contributions to a Roth IRA.
Are annual contributions required?
No, you do not have to contribute to your traditional IRA for every tax year, even if you can.
If I don’t contribute the maximum in one year, can I “catch-up” in future
No, if contributions to your traditional IRA for a year were less than the limit, you can not contribute more in a later year to make up the difference.
If I am over age 50, may I make an additional contribution?
If you are 50 or older by the close of the taxable year, you may make an additional contribution to your IRA of $1000.
Are there any restrictions on the type of contributions that can be made to a traditional IRA?
All contributions must be in the form of money (cash, check or money order). Property cannot be contributed. However, you may be able to transfer or roll over certain property from one retirement plan to another.
Are traditional IRA contributions tax-deductible?
Contributors receive a 100% deduction on their annual contribution if they are:
- A single individual who does not actively participate in an employer-sponsored retirement plan, or
- A married individual when neither spouse actively participates in an employer-sponsored retirement plan
For those covered by an employer-sponsored retirement plan, contributions will be reduced (phased out) if modified adjusted gross income is between:
- $90,000 and $110,000 for a married couple filing a joint return or a qualifying widow(er)
- $56,000 and $66,000 for a single individual or head of household, or
- $0 and $10,000 for a married individual filing a separate return
Please note that one must have earned income (from compensation or self-employment activities) at least equal to the amount of the contribution. For married couples filing jointly, either spouse can have the requisite earned income.
Can I move retirement plan assets?
The rules permit the following kinds of transfers:
Trustee to trustee transfer: A transfer of funds in your traditional IRA from one trustee directly to another, either at your request or at the trustee’s request, is not a rollover. Because there is no distribution to you, the transfer is tax free. Because it is not a rollover, it is not affected by the 1-year waiting period required between rollovers.
Rollovers: Generally, a rollover is a tax-free distribution to you of cash or assets from one retirement plan that you contribute to another retirement plan. The contribution to the second retirement plan is called a “rollover contribution”. Please note that the amount you roll over tax free is generally taxable later when the new plan distributes that amount to you or your beneficiary.
There are two kinds of rollover contributions to a traditional IRA. In one, you put amounts you receive from one traditional IRA into the same or another traditional IRA. In the other, you put amounts you receive from an employer’s qualified retirement plan for its employees into a traditional IRA.
Transfers incident to divorce: If you receive an interest in a traditional IRA as a result of a divorce or separate maintenance decree or a written document related to such a decree, the interest in the traditional IRA, starting from the date of the transfer, is treated as your traditional IRA. The transfer is tax free.
Can traditional IRA assets be moved or rolled over?
Any amount may be withdrawn from a traditional IRA tax-free and penalty-free for 60 days (once in a 12-month period, which begins on the date you receive the IRA distribution). If the IRA holder has multiple traditional IRA accounts, each account may have one rollover in a 12-month period. The money can be returned to the same account or a new traditional IRA.
If the money is not returned within 60 days, income tax is owed on the withdrawal and generally a 10% penalty is owed if the individual is under age 59 ½. Also, if any amount distributed from a traditional IRA is rolled over tax free, later distributions from that IRA within the 12-month period will not qualify as rollovers. They are taxable and may be subject to the 10% tax on early distributions.
Are distributions from a traditional IRA penalty-free?
A distribution from a traditional IRA is penalty-free if it is made:
- After the owner reaches age 59 ½,
- To a death beneficiary or the individual’s estate,
- After the owner becomes disabled,
- For expenses used to buy, build or rebuild a first home of the owner, the owner’s spouse, their children, grandchildren and ancestors (subject to a $10,000 lifetime cap),
- For higher-education expenses of the individual or the individual’s family members. Expenses include tuition, fees, room and board (if the student is enrolled at least 50% of the time), books and supplies.
Importantly, there is a 10% penalty for early withdrawals for any other reason, with certain exceptions (if unreimbursed medical expenses exceed 7.5% of AGI, if one’s withdrawals are annuitized, or if an individual collects federal unemployment benefits for 12 consecutive weeks and uses withdrawals to pay for health insurance).
When must I withdraw traditional IRA assets?
If you haven’t received the entire balance in your traditional IRA account by the required beginning date, you must begin receiving periodic distributions from your IRA accounts by April 1 of the year following the year in which you reach age 70 ½. The required minimum distribution for any year after your 70 ½ year must be made by December 31 of the later year.
If there are no distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required. Required distributions during a particular year are not eligible for rollover treatment.
What if the required distributions have begun before the owner’s death?
If periodic distributions that satisfy the minimum distribution requirements have begun and the owner dies, any undistributed amounts must be distributed at least as rapidly as under the method being used at the owner’s death. This rule does not apply if the designated beneficiary is the owner’s spouse who becomes the new owner by choosing to treat the traditional IRA as his or her own. In this case, the surviving spouse can designate beneficiaries and should follow the required distribution rules for owners of traditional IRAs, discussed above.
Note: The required minimum distribution for the year of death must be satisfied even though an eligible spouse treats an IRA as his or her own. The beneficiary (spouse) must take the necessary distribution by December 31 of the year of death if the required minimum distribution has not yet been satisfied.
Who can be designated as the beneficiary of a traditional IRA, and can the designation later be changed?
Any individual or legal entity can be designated as the beneficiary of a traditional IRA account. The IRA holder may change the designation at any time prior to the death of the IRA holder.