Traditional IRA Help
Ensuring financial security in retirement is one of the greatest challenges facing American workers today. With uncertainty over the adequacy of Social Security to meet the needs of future retirees, Americans will be forced to rely more heavily on their own resources to support their retirement lifestyle.
The world of employer-sponsored retirement plans is changing, too. Much less common today is the defined benefit plan. A defined benefit plan is the kind of plan that assures former employees a dependable income throughout their retirement years. The pension world is changing to one in which employees now carry most of the burden of saving for retirement. And even when an employer plan is available, employees may be required to make most or all of the contributions.
Traditional IRAs offer the following benefits.
- Independence – Individuals may open and fund IRAs without any employer participation
- Immediate tax advantages – Earnings remain tax-deferred until distributed
- Possible tax deductions – Eligible individuals can make deductible contributions
- Accessibility – Individuals may distribute IRA assets at any time
- Flexibility – No annual contribution requirement
To make a regular Traditional IRA contribution, the IRA owner must have eligible compensation (generally earned income) equal to or greater than the Traditional IRA contribution amount.
An IRA owner may contribute to all her Traditional and Roth IRAs up to the lesser of
- $6,000 or 100 percent of earned income, or
- $1,000 catch-up for individuals age 50+.
IRA owners age 50 or older by the end of the tax year may increase their IRA contributions to help "catch up" on their retirement savings, for a total maximum IRA contribution of $7,000 or the amount of your taxable compensation for 2021 if less. This limit can be split between a Traditional IRA and a Roth IRA but the combined limit is $7,000.
- The couple must be married and file a joint federal income tax return.
- One spouse must have compensation or earned income equal to or greater than the IRA contribution.
- The non-compensated spouse must establish an IRA.
A simplified employee pension (SEP) plan is a retirement plan that allows employers to contribute to employees’ Traditional IRAs. SEP plan contributions are subject to different contribution limits than Traditional IRA contributions. Once an employer makes a SEP plan contribution to an IRA, all the general Traditional IRA rules and regulations apply. SEP plan contributions do not affect the individual's ability to make Traditional IRA contributions. The following characteristics apply to SEP plan contributions.
- The maximum SEP plan contribution is the lesser of 25 percent of compensation up to $58,000 for 2021.
- SEP contributions are always 100 percent vested.
- Eligible participants who are age 72 or older may receive SEP plan contributions.
Individuals must make regular contributions to Traditional and Roth IRAs by the due date of their federal income tax returns (generally April 15), not including extensions. If the deadline for filing an individual's income tax return falls on a Saturday, Sunday, or legal holiday, he will have until the following business day to make his contribution.
Contributions made between January 1 and April 15 of one year for the previous year are called prior-year contributions.
Yes. Traditional IRA owners are permitted to make nondeductible IRA contributions if they are not eligible for a tax deduction or if they choose to not take a deduction. The combined total of deductible and nondeductible contributions cannot exceed the annual contribution limit of $6,000, plus catch-up contributions if eligible, or 100 percent of earned income, whichever is less. IRA owners track their nondeductible IRA contributions by filing Form 8606, Nondeductible IRAs, with their federal income tax returns.
One of the benefits of contributing to a Traditional IRA is that the contribution may be tax deductible. Whether a contribution or a portion of a contribution is deductible depends on active participation (participating in or receiving contributions) in an employer-sponsored retirement plan, marital status, and modified adjusted gross income (MAGI).
IRA Deductibility Phase-Out Ranges for Active Participants
|Filing Status||2021 MAGI|
|Single and Head of Household||$66,000-$76,000|
|Married Filling a Joint Tax Return||$105,000-$125,000|
|Non-active Participant Married to an Active Participate||$198,000-$208,000|
|Married Filing Separate Tax Return||$0-$10,000|
IRA owners may wish to move their IRAs from one financial organization to another. Transfers and rollovers are two methods of moving assets from one IRA to another IRA of the same type.
A transfer is a direct movement of assets between like IRAs. A transfer generally is from one financial organization to another financial organization, but may occur between IRAs at the same financial organization. Although IRA owners direct the asset transfer, they do not have actual receipt of the assets. An IRA owner may make an unlimited number of transfers in a year. The transfers may be for all or any part of an IRA balance. Transfers are not reported to the IRS.
An IRA-to-IRA rollover is another method of moving assets, tax-free from one IRA to another IRA of the same type. With rollovers, the IRA owner, surviving spouse beneficiary, or former spouse actually receives the assets through a distribution before rolling it over to another IRA. A distribution that is eventually rolled over to an IRA is treated like any other type of distribution at the time it is taken from the IRA. Consequently, the withholding rules apply. The distributing financial organization reports the IRA distribution on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., and the receiving financial organization reports the rollover contribution on Form 5498,IRA Contribution Information.
Contributions made by an employer through a retirement plan known as a simplified employee pension (SEP) plan are contributed to Traditional IRAs. Once SEP plan assets are in the Traditional IRA, all the general Traditional IRA rules and regulations apply. They do not, however, affect an IRA owner’s ability to make regular Traditional IRA contributions. But participating in the SEP plan makes an individual an active participant for purposes of Traditional IRA deductions.
Traditional IRAs also may receive rollovers of pretax and after-tax assets from employer-sponsored retirement plans, which include 401(a) and 403(a) qualified retirement plans (QRPs), 403(b) plans, governmental 457(b) plans, the federal Thrift Savings Plan, and SIMPLE IRA plans (after two years of participation in the SIMPLE IRA).
Recharacterized assets also may be contributed to a Traditional IRA.
Unlike many employer-sponsored retirement plans in which access to assets might be limited until the participant has a change of employment or reaches retirement age, access to IRA assets is guaranteed, always. Most Traditional IRA distributions taken before the IRA owner reaches age 59½ are subject to a 10 percent early distribution penalty tax. This is to discourage people from taking Traditional IRA distributions at an early age rather than keeping the assets for retirement. The 10 percent early distribution penalty tax does not apply in the following situations.
- Age 59½
- Certain medical expenses
- Health insurance premiums following unemployment
- First home buyer expenses
- Higher education expenses
- IRS levy
- Series of substantially equal periodic payments
- Qualified reservist distributions
IRS Publication 590, Individual Retirement Arrangements (IRAs), provides more detail on these penalty tax exceptions.
Traditional IRA distributions become mandatory beginning in the year that a Traditional IRA owner turns age 72. These mandatory distributions are called required minimum distributions (RMDs). IRA owners must begin taking RMDs by April 1 of the year following the year they turn 72. These distributions are based on the IRA balance divided by the applicable distribution period. Because IRAs were created to provide income during retirement—not to be a tax shelter— IRA owners failing to take their RMDs are subject to a 50 percent excess accumulation penalty tax on the assets that should have been distributed but were not.
The difference between a Traditional and Roth IRA can be summarized by the following comparison.
|Traditional IRA:||Regular contributions may be tax-deductible|
|Roth IRA:||No deductions|
|Roth IRA:||Tax-free if used properly|
|Traditional IRA:||Includable in taxable income|
|Roth IRA:||Tax-free for qualified distributions|
Each of the following factors determines whether a Traditional IRA or a Roth IRA is the right choice for you.
- Anticipated tax rate at retirement
- Years to retirement
- Current tax rate
- Earnings rate assumptions
- Distribution plans at retirement