In 1974, Congress enacted the Employee Retirement Income Security Act (today known as ERISA) and Individual Retirement Accounts (IRA’s) were introduced on to the scene where participants at that time could put away as much as $1,500 a year toward their retirement.
The legislation went through a few overhauls during the Reagan years in 1981 and 1986, and have had a several transformations over the past twenty years. Most families and small business owners are still unaware on exactly how the rules work when it comes to contributing to a traditional IRA account. So here are a few facts you should know about these accounts almost forty years into the making.
- You must have earned income to be able to contribute to a traditional IRA. This includes compensation such as commissions, wages, bonuses, self-employment income, etc.- the key is EARNED income. You can’t make a contribution more than the earned income you have in that particular tax year.
- The maximum contribution in 2013 is $5,500 for those under the age of 50 and a catch up contribution of $1,000 ($6,500 total) for those over the age of 50.
- If neither you nor your spouse is covered by an employer sponsored retirement plan, you can fully deduct your contributions. However, for contributions you made to a traditional IRA, the amount you can deduct may be limited depending on if you are covered by a retirement plan at work and your overall income level.
- You can always contribute to a traditional IRA account no matter what your income level is if you want to save additional dollars on a tax-deferred basis for retirement. However, the chart below specifies at what level you can take a tax deduction if you (or your spouse) is eligible to participate in an employer sponsored retirement plan.
|If you are covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction. Source (www.irs.gov)|
|If Your Filing Status Is…||Your Modified AGI Is…||Then You Can Take…|
|Single or Head of Household||$59,000 or less||a full deduction up to the amount of your contribution limit.|
|$59,001 – $68,999||a partial deduction.|
|$69,000 or more||no deduction.|
|Married filing jointly or Qualifying Widow(er)||$95,000 or less||a full deduction up to the amount of your contribution limit.|
|$95,001 – $114,999||a partial deduction.|
|$115,000 or more||no deduction.|
|Married filing separately||less than $10,000||a partial deduction.|
|$10,000 or more||no deduction.|
|If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the “Single” filing status.|
- Many people forget that a working spouse who is NOT covered by an employer sponsored retirement plan, you can fully deduct the traditional IRA contribution for that spouse if you are below the AGI limitations discussed above. Remember that you need to be married and file a joint tax return to make this happen.
- Remember, that if you are self-employed and net at least the annual contribution limits, you could use an IRA as a retirement savings vehicle. It’s unlikely that $5,000 or $6,000 a year will get you to retirement, but it is a low cost simple to implement vehicle for retirement savings.
- Last, be 100% certain that you can lock this money up for many years down the road. IRA contributions are still subject to early penalties and potential taxation if you take the money before the age of 59 ½ unless you distribute the money through an SEPP distribution.
If you run a small business or if you maxed out other retirement savings plans, a traditional IRA can still be a good overall investment option. Many people don’t look at this before they file their taxes as contributions don’t generally need to be made until April 15th. Always consult your financial advisor and/or CPA before making a traditional IRA contribution.
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Ted Jenkin, CFP®, AAMS®, AWMA®, CRPC®, CMFC®, CRPS®, is co-CEO of oXYGen Financial and is a top ranked personal finance blogger (www.yoursmartmoneymoves.com). He is a regular contributor to Investment News, The Wall Street Journal, and The Atlanta Journal Constitution. Securities and Investment Advisory Services offered through NFP Advisor Services, LLC (NFPAS), Member FINRA/SIPC. Oxygen Financial is not affiliated with NFPAS.