IRAs – what they are

18 September 2019

IRAs are easy to set up — but it’s not always easy to make the most of your investment alternatives.

IRAs, or individual retirement accounts, are tax-deferred, personal retirement plans. You can contribute every year you have earned income whether or not you participate in an employer’s retirement plan. There are two types: the traditional IRAs, to which contributions may be deductible or nondeductible, and the Roth IRA.

  • All traditional IRAs are tax deferred, which means you owe no tax on your earnings until you withdraw
  •  Roth IRAs are also tax deferred, which means you owe no tax on your earnings as they accumulate. Withdrawals will be tax free if you follow the rules

A sweet deal

The only requirement for opening an IRA is having earned income — money you make for work you do. Your total annual contribution is limited to the annual cap. That’s $6,000 in 2022, whether you choose a traditional IRA or a Roth. If you’re 50 or over, you can also make an additional annual catch-up contribution of $1,000.

Any amount you earn qualifies, and you can contribute as much as you want, up to the cap. But you can’t contribute more than you earn.

Spousal accounts

If your husband or wife doesn’t work, but you do, you can put up to the annual limit into a separate spousal IRA in addition to your own contribution. The advantage for the nonworking spouse is being able to build an individual retirement fund.

Which IRA for you?

In addition to having earned income, you must qualify to deduct your contributions to a traditional IRA or contribute to a Roth IRA. The rules are different in each case.

If you’re single, you qualify for a fully deductible IRA contribution when you file your federal income tax return if you were not covered by an employer sponsored retirement plan during that year. If you were covered by a plan, you may be able to deduct some or all of your contribution based on your modified adjusted gross income (MAGI).

If you’re married and file jointly, both of you can deduct your own contribution if neither of you is covered by a retirement plan at work. But if either of you is covered by a plan, the other’s right to a deduction is reduced gradually if your joint MAGI is over $204,000 and eliminated if it’s over $214,000 in 2022. If you’re both covered, the limits are $109,000 and $129,000 in 2022.

Eligibility for a Roth IRA is based on your filing status and MAGI, with higher income limits for married couples filing a joint return than for single filers. If you qualify to make a partial contribution to a Roth, you can put the balance in a traditional IRA. Married couples filing separate returns usually aren’t eligible either to deduct contributions or contribute to a Roth.

While you can’t deduct your contribution to a Roth IRA, taxes on earnings in your account are deferred as they accumulate, and you make tax-free withdrawals if you qualify. In most cases, that means you are at least 59½ and have had your account open at least five years before you withdraw.

It’s your account

It’s easy to open an IRA. All you do is fill out a relatively simple application provided by the mutual fund company, bank, brokerage firm, insurance company, or other financial institution you choose to be custodian of your account.

Because IRAs are individual, meaning that you decide how to invest the money, you’re responsible for following the rules that govern the accounts. Basically, that means putting in only the amount you’re entitled to each year. You must also report your contribution to a traditional IRA to the IRS, on Form 1040 or 1040A if it’s deductible and on Form 8606 if it’s not.

You can invest your IRA money any way that is available through your custodian including individual securities, funds, and bank products. The things you can’t buy are fine art, gems, non-US coins, and collectibles. And you can sell investments in your IRA account without paying tax on your gains until you withdraw from your account, but there may be transaction costs.

When to contribute

You have until the day taxes are due — usually April 15 — to open an IRA and make the contribution for the previous tax year.

You can contribute to your IRA in a lump sum or spread the deposit out over the year. You may put in the whole amount the first day you can, January 1 of the tax year you’re making the contribution for, to give your money the longest time to grow. If you’re like most people, you’re more apt to make the deposit the last possible day. The most practical solution may be making contributions on a regular schedule.

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This information is provided with the understanding that the authors and publishers are not engaged in rendering financial, accounting or legal advice, and they assume no legal responsibility for the completeness or accuracy of the contents. Some charts and graphs have been edited for illustrative purposes. The text is based on information available at time of publication. Readers should consult a financial professional about their own situation before acting on any information.

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