Both Traditional and Roth IRAs offer tax advantages for long-term retirement planning. As you compare these two options, you’ll want to understand the implications and rules for the Traditional and Roth IRA contributions. Show
What’s an IRA?You may have heard the acronym IRA before, but if not we’ll walk you through what an IRA stands for. An IRA is an Individual Retirement Account — and it’s a term used to describe two types of retirement accounts: Roth and Traditional. Both have tax advantages, but have different rules and contribution limits. Individuals open IRAs to save and invest in the long term. What’s the difference between a Roth and a Traditional IRA?Two common types of IRAs are traditional IRAs and Roth IRAs. Earnings in these accounts can accumulate either tax-free or taxed at a later date. Also, you may be able to deduct traditional IRA contributions. Traditional IRA rulesYou can get a traditional IRA if you receive taxable compensation. This compensation includes:
Income not included as compensation for IRA purposes includes:
The maximum amount you can contribute to all IRAs must be the lesser of these:
Ex: If you earn $2,000, then your maximum IRA contribution for the year is $2,000. The maximum amount increases to $7,000 (up to taxable compensation) if both of these apply:
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. However, you will not have to pay this excise tax if you withdraw the excess by the tax return due date (plus extensions). 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 $6,000 (or their compensation amount if lower). You must begin withdrawing from your traditional IRA by April 1 the year after the year you reach age 72. Note: The required beginning date for required minimum distributions was recently updated to 72. Who can deduct a Traditional IRA contribution?These two tests determine how much of your IRA contributions are deductible:
Active participant testThe W-2 your employer sends you should show if you’re an active participant for the tax year in an employer-sponsored plan. If you’re an active participant, the Retirement Plan box should be checked. If neither you nor your spouse were active participants in a company plan, you can deduct your traditional IRA contributions regardless of how high your income is. IRA income testIf 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 for 2022:
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:
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:
If your income is too high to deduct contributions to a traditional IRA, you might qualify for a Roth IRA. However, contributions to a Roth IRA aren’t tax deductible. Roth IRA contributions are still a long-term investment in a retirement savings plan. Roth IRA rulesRoth IRAs are subject to the same rules as traditional IRAs. However, there are some exceptions:
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. The amount you can contribute to a Roth IRA 2022:
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:
Spousal IRAsIf you’re married and one spouse doesn’t receive compensation or makes less compensation, you can open an IRA account for the spouse making less taxable compensation than the other spouse. You can contribute up to the maximum for each spouse, as long as you don’t exceed the total compensation received by both spouses [on a married filing joint return]. When both spouses are age 50 or older, the limit is $7,000 per spouse. Choosing your IRA trusteeYou 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:
Some IRA accounts have annual fees, while others have no fees. You can have many IRA accounts. You can:
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. Due date for IRA contributionsThe last day to make your IRA contribution each year is the day your return is due for the year, not including extensions. You can mail your IRA contribution, and you’ll meet the deadline if it’s postmarked by the original due date for filing Form 1040. IRA recordkeepingIf you have contributed to a nondeductible traditional IRA, you must keep track of your basis. By doing so, you can make sure you won’t pay tax on the money again when you withdraw it. Basis is usually the combination of these:
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-B 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. IRA rules – Moving your money aroundYou 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. Converting your Traditional IRA to a Roth IRAMoving money from your traditional IRA to a Roth IRA is called a conversion. If you don’t have basis in your traditional IRA, the entire amount will be included in your income. Otherwise, the amount included in income is calculated as if you were taking a withdrawal from traditional IRA. You can convert funds from your traditional IRA to a Roth IRA regardless of your income. One method of conversion is to take a distribution from the traditional IRA and contribute it (rollover) into a Roth IRA within 60 days from the date of distribution. Contributing too much to an IRAIf you make excess IRA contributions, you’re subject to a 6% tax. The penalty applies each year until you either:
If you withdraw the excess amount plus any related earnings before the due date, including extensions:
Roth or Traditional IRA helpIf you’re seeking investment guidance, consult a certified financial planner. For tax guidance around investments, find an H&R Block tax office location nearest you. Can I contribute to both a SIMPLE IRA and a Roth IRA?Yes, you can contribute to a traditional and/or Roth IRA even if you participate in an employer-sponsored retirement plan (including a SEP or SIMPLE IRA plan).
How much can I contribute to my Roth IRA and SIMPLE IRA?For 2022, 2021, 2020 and 2019, the total contributions you make each year to all of your traditional IRAs and Roth IRAs can't be more than: $6,000 ($7,000 if you're age 50 or older), or. If less, your taxable compensation for the year.
Does SIMPLE IRA count towards IRA limit?SIMPLE IRA contribution limits
If you contribute to any defined contribution plans, such as a 401(k), note that your SIMPLE IRA contributions count against the total contribution limit you can make for those plans ($61,000 in 2022, up from $58,000 in 2021).
Can you max out a SIMPLE IRA and a traditional IRA in the same year?SIMPLE IRA Contribution Limits
You cannot max out both a SIMPLE IRA and another employer-sponsored retirement plan, like a 401(k). The annual limit for combined SIMPLE IRA and 401(k) contributions can't be more than $20,500 in 2022, or $27,000 if you're 50 or older.
|