An IRA PrimerEverything you ever wanted to know about individual retirement accounts
Who's Eligible?
Tax-Deductible IRA
- A single person who has not actively participated in or qualified for an employer-sponsored retirement plan at any time during the year (including a self-employed plan set up for that person).
- A single person who actively participates in an employer-sponsored retirement plan and who has an AGI below $55,000 for 2004 ($60,000 for 2005), subject to phase-out rules.
- A married person when neither spouse actively participates in an employer-sponsored retirement plan.
- Both spouses when a joint return is filed, both are active participants in employer-sponsored retirement plans and joint AGI is below $75,000 for 2004 ($80,000 for 2005), subject to phase-out rules.
- A married person who actively participates in an employer-sponsored retirement plan but whose spouse does not, provided the couple files jointly and has AGI below $75,000 for 2004 ($80,000 for 2005), subject to phase-out rules.
- A married person who does not actively participate in an employer-sponsored retirement plan but whose spouse actively participates in such a plan, provided the couple files jointly and has joint AGI below $160,000 (subject to phase-out rules).
- A married person filing separately with AGI below $10,000 (subject to phase-out rules) who actively participates in an employer-sponsored retirement plan or who has a spouse who actively participates.
- A married person who: (a) files a separate return, (b) has been separated from the spouse for at least one year, (c) is an active participant in an employer-sponsored retirement plan and (d) meets the AGI rule for singles in item 2 above.
Note: In all cases, the taxpayer must have earned income (from compensation or self-employment activities) at least equal to the amount contributed to the IRA. For married couples filing jointly, either spouse can have the requisite earned income.
Nondeductible IRA
- Anyone--regardless of AGI level--provided he or she has earned income at least equal to the amount contributed to the IRA.
Roth IRA
- A single person with an AGI below $110,000 (subject to phase-out starting at $95,000).
- Married people filing jointly with AGIs below $160,000 (subject to phase-out starting at $150,000).
- Married people filing separately with AGIs below $10,000 (subject to phase-out starting at zero).
Note: In all cases, the taxpayer must have earned income (from compensation or self-employment activities) at least equal to the amount contributed to the Roth IRA. For married couples filing jointly, either spouse can have the requisite earned income.
How Much Can I Contribute?
Tax-Deductible IRA
For 2004, the maximum deductible contribution is the lesser of earned income or $3,000/$3,500 if the individual will be age 50 or older at year-end ($6,000 for married couples filing jointly; $7,000 if both spouses will be age 50 or older as of year-end). For 2005, the contribution limits are $4,000/ $4,500 (and $8,000/ $9,000 for a married couple). These deductible-contribution maximums are subject to the following phase-out rules:
- If you are single and an active participant in an employer-sponsored retirement plan (including a self-employed plan set up for you), the AGI phase-out range is $45,000 to $55,000 for 2004 ($50,000 to $60,000 for 2005). For example, if your 2005 AGI is $52,000, your maximum deductible contribution is $3,200 ($3,600 if you will be 50 or older as of year-end).
- 如果你是单身,而不是一个活跃的参与者,your maximum deductible contribution for 2004 is $3,000 or $3,500 if you were age 50 or older by year-end, regardless of your AGI ($4,000/ $4,500 for 2005).
- If you are married, and both you and your spouse are active participants, the joint AGI phase-out range for deductible contributions for both of you is $65,000 to $75,000 for 2004 ($70,000 to $80,000 for 2005). For example, if your 2004 joint AGI is $67,000, the maximum deductible contribution for you and your spouse is $2,400 each or $2,800 each if you were both age 50 or older at year-end (for a total of $4,800 or $5,600 if you were both 50 or older at year-end).
- If you are married, and your spouse is an active participant, but you are not, the joint AGI phase-out range for your deductible contribution is $150,000 to $160,000.
- If you are married, and you are an active participant, but your spouse is not, the joint AGI phase-out range for your deductible contribution is $65,000 to $75,000 for 2004 ($70,000 to $80,000 for 2005).
- If you are married, and neither you nor your spouse is an active participant, both of you can contribute and deduct up to $3,000 or $3,500 each if you were both age 50 or older at year-end (total of $6,000 or $7,000 if you will both be 50 or older) regardless of your AGI. For 2005, the contribution limits are $4,000/ $4,500 (and $8,000/ $9,000 for a married couple.)
- If you are married and filing separately, and either you or your spouse is an active participant, the AGI phase-out range for your deductible contribution is $0 to $10,000.
- If you are married and filing separately, have been separated from your spouse for at least one year and are an active participant, the AGI phase-out range for your deductible contribution is $45,000 to $55,000 for 2004 ($50,000 to $60,000 for 2005). If you are not an active participant, you can contribute and deduct up to $3,000 for 2004 regardless of your AGI ($3,500 if you were 50 or older at year-end). For 2005, the limit is $4,000 (or $4,500 if you are over 50).
Note: In all cases, the taxpayer must have earned income (from compensation or self-employment activities) at least equal to the amount contributed to the IRA. For married couples filing jointly, either spouse can have the requisite earned income.
Nondeductible IRA
For 2004, the maximum contribution is the lesser of earned income or $3,000 or $3,500 if you were age 50 or older at year-end. This contribution is not tax-deductible. For 2005, the maximum contribution is $4,000, or $4,500 if you are 50 or older at yearend.
Roth IRA
For 2004, the maximum contribution is the lesser of earned income or $3,000 or $3,500 if you were age 50 or older at year-end. For 2005, the contribution limit is $4,000, or $4,500. The maximum contribution is phased-out between the following AGI levels:
- If you are single, $95,000 to $110,000.
- If you are married filing jointly, $150,000 to $160,000.
- If you are married filing separately, $0 to $10,000.
Note: In all cases, the taxpayer must have earned income (from compensation or self-employment activities) at least equal to the amount contributed to the Roth IRA. For married couples filing jointly, either spouse can have the requisite earned income.
| Taxes Due After Age 59 1/2 | |
| Tax-Deductible IRA | Income tax due on earnings and original contributions. |
| Nondeductible IRA | Income tax due on earnings (original contributions are withdrawn tax-free). |
| Roth IRA | No tax due if funds are held in the account for at least five years and you are at least age 59 1/2. Total amount of annual contributions can be withdrawn tax-free and penalty-free at any time. |
| Early Withdrawal (Before Age 59 1/2)--Higher Education | ||
| IRA Type | 10% Penalty | Income Tax Due |
| Tax-Deductible IRA | No | Yes |
| Nondeductible IRA | No | On earnings, not original contributions |
| Roth--Less than five years old | No | On earnings, not original contributions |
| Roth--More than five years old | No | On earnings, not original contributions |
Higher-education expenses must be for you or your family members. Expenses include tuition, fees, room and board (if the student is enrolled at least part time), books and supplies.
| Early Withdrawal (Before Age 59 1/2)--First-Time Home Purchase | ||
| IRA Type | 10% Penalty | Income Tax Due |
| Tax-Deductible IRA | No | Yes |
| Nondeductible IRA | No | On earnings, not original contributions |
| Roth--Less than five years old | No | On earnings, not original contributions |
| Roth--More than five years old | No | No |
Limit is $10,000 over your lifetime. To qualify, you must not have owned a home for the past two years. This exemption can be used to buy, build or rebuild a first home for you, your parents, your children or your grandchildren. If you use only part of your exemption, you can use the remainder another time.
| Early Withdrawal (Before Age 59 1/2)--Death or Disability | ||
| IRA Type | 10% Penalty | Income Tax Due |
| Tax-Deductible IRA | No | Yes |
| Nondeductible IRA | No | On earnings, not original contributions |
| Roth--Less than five years old | No | On earnings, not original contributions |
| Roth--More than five years old | No | No |
| Early Withdrawal (Before Age 59 1/2)--Any Other Reason | ||
| IRA Type | 10% Penalty | Income Tax Due |
| Tax-Deductible IRA | Yes, with exceptions* | Yes |
| Nondeductible IRA | On earnings, with exceptions* | On earnings, not original contributions |
| Roth--Less than five years old | On earnings, with exceptions* | On earnings, not original contributions |
| Roth--More than five years old | On earnings, with exceptions* | On earnings, not original contributions |
*Exceptions include: (a) if your medical expenses exceed 7.5% of your AGI; (b) if you annuitize your withdrawals; (c) if you collect federal unemployment benefits for 12 consecutive weeks and use IRA withdrawals to pay for health insurance.
| SEP* and SIMPLE** IRAs | ||
| SEP IRA | SIMPLE IRA | |
| Eligibility | 1. Anyone who is self-employed. 2. Any employed person with freelance income. 3. Any business owner. |
1. Employers with 100 employees or fewer who do not maintain any other retirement plan. 2. Any self-employed person who does not maintain another retirement plan. |
| Annual Contributions for 2005 | For self-employed: 20% of self-employment income up to $42,000. For employees: 25% of salary up to $42,000. | $10,000 in employee contributions ($12,000 if employee will be age 50 or older at year-end). Employer must match up to 3% of compensation. (In certain situations, the match can be 1% to 2%.) The alternative choice is an automatic 2% match for all employees. All employee and employer contributions are immediately vested. |
| Withdrawals after age 59 1/2 | Taxes due on earnings and contributions | Taxes due on earnings and contributions |
| Withdrawals before age 59 1/2 | 10% early-withdrawal penalty plus taxes. Penalty exemptions may apply | If funds are held for less than two years, there is a 25% early-withdrawal penalty plus taxes. After two years, there is a 10% withdrawal penalty plus taxes. Penalty exceptions may apply. |
*Simplified Employee Pension Plan.
**Savings Incentive Match Plan for Employees.
What's AGI?
Your adjusted gross income is the number at the bottom on page 1 of your 1040. Specifically, it's your gross income minus so-called above-the-line deductions. These are deductible IRA contributions (as well as deductible SEP, SIMPLE and Keogh contributions), the student-loan-interest deduction, deductible contributions to medical savings accounts, the moving-expense deduction, half of the self-employment tax paid by self-employed individuals, the deduction for health-insurance premiums paid by self-employed persons, the deduction for higher education expenses, penalties on the early withdrawal of savings and deductible alimony payments, and legal fees for certain litigation settlements and awards. AGI does not include the standard deduction or itemized deductions. However, the key figure for purposes of calculating eligibility for deductible IRA and Roth contributions is actually "modified" adjusted gross income, or MAGI. This is your AGI (as explained) with the following adjustments:
- add back deductible IRA contributions,
- add back the student-loan-interest deduction,
- add back the deduction for higher education costs,
- add back U.S. Savings Bond interest excluded from taxation because it's used to pay higher-education expenses,
- add back certain employer adoption-assistance payments excluded from taxation,
- add back certain foreign earned-income and foreign-housing-cost reimbursements excluded from taxation, and
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For simplicity's sake, we have used AGI throughout this article when we really mean MAGI. However, for most people, the MAGI number will simply equal AGI before taking into account deductible IRA contributions. A fair number of people will then have to consider the add-backs for items 2, 3 and 4 above. Fewer will be affected by the add-backs for items 5, 6 and 7 above.
What's Earned Income?
This is income that you have actually worked for--like salary or self-employment income. It also includes any taxable alimony payments you receive. It does not, however, include investment income such as interest, dividends or profits from sales. It also does not include earnings from pensions or annuities.
Tax-Free 60-Day Withdrawals
IRA funds can be withdrawn tax-free and penalty-free for 60 days, provided the full amount is returned to the account within this time period. The money can be returned to the same account or to a new IRA. In effect, this is like being able to take a short-term, interest-free loan from your IRA. However, you can do this just once in any 12-month period. If you don't replace the money within 60 days, you will owe income tax on the withdrawal and generally a 10 percent penalty if you are under age 59 1/2.
FromSmartMoney.com. Copyright © 2005 SmartMoney.com. All rights reserved.
