28 Oct What to Know About Traditional IRAs
It’s never too early to start thinking about retirement. Whether you’re 20 or 50, you need a plan for your post-career life, and an individual retirement account (IRA) may be the answer. There are a few different types of IRAs, including traditional IRA, Roth IRA, SEP IRA, and SIMPLE IRA. The traditional IRA is quite common and has many benefits.
Unlike a 401(k)—another type of retirement account—a traditional IRA isn’t funded through your job, but individually. It can be especially beneficial if you don’t have access to a 401(k) or have maxed out your employer’s retirement plan.
While each of the various types of IRAs has different advantages and limitations, they all provide tax benefits. Like 401(k) accounts, traditional, SEP, and SIMPLE IRAs are tax-deferred, meaning taxes are paid at withdrawal, rather than in the beginning. Roth IRAs are tax-free, and those contributions have already been taxed.
Contributions Limited to Earned Income
You can only contribute earned income to your IRA. Even though an IRA is funded individually and not taken from your paycheck, you cannot contribute more than $5,500 or your annual taxable compensation (2016). If you have both a traditional IRA and a Roth IRA, total contributions to both accounts cannot exceed this limit.
No Minimum Age Requirement
The IRS doesn’t impose a minimum age requirement to open and fund a traditional IRA, so it’s a good idea to start early. While you can’t exactly contribute to your small child’s IRA, you can help your teenager set up his or her IRA with money they earned through a summer job or on the weekends. As long as the money is taxable income and the contribution limitations are observed, it can be contributed. What a great way to start your child off on a good path to financial freedom!
Higher Contribution Limit for Ages 50+
Traditional IRAs have contribution limits1, and you’ll be penalized for putting in more than the allowable amount, which for 2016 is $5,500. However, if you’re at least 50 years old, you can contribute a higher annual amount than younger people. For 2016, the limit is $6,500.
Despite the earned-income rule about contributions, you can contribute to a traditional IRA for a non-working spouse. However, the contributor’s taxable income cannot be less than the total contribution amount for both people. For example, a working husband under the age of 50 can contribute $5,500 for himself along with an additional $5,500 for his wife, as long as he earns at least $11,000 annually. This is a helpful rule for many couples with one stay-at-home parent. The limit increases to $6,500 per spouse if both people are over the age of 50.
It may seem like the IRA contribution deadline should be at the end of a given year—and many tax deadlines are—but you can still contribute to an IRA up until the income tax deadline, which is usually April 15 of the following year. This means that you have until Tax Day to add as much as the annual contribution limit to your IRA.
Although Tax Day usually falls on April 15, there are stipulations: the deadline can’t fall on a weekend, and it cannot fall on a legal holiday. This year, the deadline for most people to file 2015 income taxes was April 18, 2016. Even though it was a Friday, April 15 happened to coincide with Emancipation Day—a holiday observed in Washington D.C.—so the income tax deadline was pushed to the following Monday, April 18.
Early Withdrawal for a Traditional IRA
Typically, you can’t access your IRA money before age 59½ without a 10% early-withdrawal penalty, but life sometimes demands it. Though you should try to avoid early withdrawal, there are some exceptions that allow penalty-free early withdrawals. These exceptions are explained in detail in section 72(t) of the tax code.
Required IRA Withdrawal
Though it’s not advisable to withdraw from your IRA too early, you also can’t leave the money in there for too long. Once you turn 70½, you can no longer contribute to an IRA. You must start withdrawing the money no later than April 1 of the year following the year in which you turn 70½. Your first required minimum distribution (RMD) must be withdrawn at that time. The amount of your RMD is determined by your age and the funds in your IRA. You can determine your RMD using the Raymond James RMD calculator.
As you can see, there are many benefits to IRAs, but you have to know the rules. This article is not an exhaustive list of IRA rules, but a CERTIFIED FINANCIAL PLANNER™ (CFP®) professional can help you navigate the ins and outs of retirement planning. Call 615-861-6101 today to speak with Deering Wealth Team.
- If your annual compensation was less than the dollar limit, your IRA contribution cannot exceed your taxable compensation for the year. The IRA contribution limit does not apply to rollover contributions or qualified reservist repayments. Your Roth IRA contribution could be limited due to your income and filing status. Please visit IRS.gov for more details.