March 25, 2021

IRA

Your Guide

Definition

Individual retirement arrangement (IRA) is an umbrella term that covers individual retirement account and individual retirement annuity. These are retirement savings vehicles established by individual taxpayers.

There are several versions of an individual retirement arrangement,

(a) traditional IRAs, where assets accrue earnings on a tax-deferred basis and distributions are treated as ordinary income,

(b) Roth IRAs, where assets accrue on a tax-deferred basis, but qualified distributions are tax-free

(c) SEP IRAs, which are established and funded by business owners/employers for their employees. The funding vehicle for a SEP IRA is a traditional IRA and

(d) SIMPLE IRAs, are established and funded by business owners/employers for their employees. Employees may also make salary deferral contributions to SIMPLE IRAs, and versions of SEPs that are referred to as SARSEPs.

  • Individual retirement account is the ‘account’ version of an individual retirement arrangement. The account can be established at a bank, credit union, brokerage firm, savings & loan, or other financial institution that satisfies the requirements established under the tax code IRC § 408(n)
  • Individual retirement annuity is the annuity-contract version of an individual retirement arrangement, issued by an insurance company. IRC § 408(b)

Referring Cite

IRC § 408 (a), IRC § 408 (b), IRS Publication 590

Additional Helpful Information

Individuals may contribute up to 100% of their taxable compensation/income up to the dollar limit that is in effect for the year to their traditional and/or Roth IRAs. Individuals who reach age 50 by the end of the year may contribute additional amounts referred to as ‘Catch-up’ contributions.

The dollar limits for 2002  and after are as follows:

Year

IRA contribution  limit

Catch-up contribution limit

2005

$4,000

$500

2006

$4,000

$1,000

2007

$4,000

$1,000

2008

$5,000

$1,000

2009

$5,000

$1,000

2010

$5,000

$1,000

2011

$5,000

$1,000

2012

$5,000

$1,000

2013

$5,500

$1,000

2014

$5,500

$1,000

2015

$5,500

$1,000

2016

$5,500

$1,000

2017

$5,500

$1,000

2018

$5,500

$1,000

2019$6,000$1,000
2020$6,000$1,000
2021$6,000$1,000
  • An individual can split the annual limit between a traditional and a Roth IRA, or contribute the entire amount to either. Eligibility requirements apply to Roth IRA contributions.
  • These contributions must be made in cash

Roth IRA Contributions Eligibility Limits

Individuals may contribute to a Roth IRA only if their MAGI does not exceed a certain amount. The limits are as follows:

Tax Filing Status

2021 MAGI

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2020 MAGI

Allowed contribution

Single or Head of Household

$125,000 or less

$124,000 or less

100%

$125,000 to $140,000

$124,000 – $139,000

Partial

$140,000 or more

$139,000 or more

None

Married filing jointly

$198,000 or less

$196,000 or less 

100%

$198,000 to $208,000

$196,000 -$206,000

Partial

$208,000 or more

$206,000 or more

None

Married filing separately

Less than $10,000

Less than $10,000

Partial

$10,000 or more

$10,000 or more

None

Traditional IRA Deductibility

Individuals who are active participants are eligible to deduct their traditional IRA contributions, only if their MAGI amounts do not exceed certain limits. For details on how this works, see the article Active Participant Status–Can You Deduct Your IRA Contribution?

The MAGI that applies to each tax-filing status is as follows:

Tax Filing Status

2021 MAGI

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2020 MAGI

Allowed deduction

Single or Head of Household  

$66,000 or less

$65,000 or less

100%

$66,000 – $76,000

$65,000 – $75,000

Partial

$76,000 or more

$75,000 or more

None

Married filing jointly or a qualifying widower, and active

$105,000 or less

$104,000 or less

100%

$105,000- $125,000

$104,000- $124,000

Partial

$125,000 or more

$124,000 or more

None

Married filing jointly. Not active, but spouse is active

$198,000 or less

$196,000 or less

100%

$198,000 – $208,000

$196,000 – $206,000

Partial

$208,000 or more

$206,000 or more

None

Married filing separately

Less than $10,000

Less than $10,000

Partial

$10,000 or more

$10,000 or more

None

Written By

Retirement Dictionary Staff

Frequently Asked Questions Regarding

Yes. You are not treated as an active participant for any taxable year because of the following:

  • You are covered under a social security or railroad retirement
  • You receive retirement benefits from a previous employer’s plan
  • The only reason you participate in a plan is because you are a member of a reserve unit of the armed forces and both of the following conditions are met.
    • The plan you participate in is established for its employees by:
      1. The United States,
      2. A state or political subdivision of a state, or
      3. An instrumentality of either (a) or (b) above.
  • You did not serve more than 90 days on active duty during the year (not counting duty for training).
  • The only reason you participate in a plan is because you are a volunteer firefighter, and both of the following conditions are met.
    • The plan you participate in is established for its employees by:
      1. The United States,
      2. A state or political subdivision of a state, or
      3. An instrumentality of either (a) or (b) above.
    • Your accrued retirement benefits at the beginning of the year will not provide more than $1,800 per year at retirement, (when expressed as a single life annuity commencing at age 65).

It is not necessary to establish a separate IRA for nondeductible contributions, as all of the individual’s traditional, SEP and SIMPLE IRAs are treated as one IRA for purpose of determining the taxable amount of any distribution from either of those IRAs. For instance, assume he has three IRAs, one with $2,000 nondeductible contribution, another with $4,000 deductible contributions, and the third with $4,000 SEP IRA contribution. If he takes a distribution of $2,000, the distribution will be prorated to include 1/5 nontaxable amount and 4/5 taxable amount, regardless of which of the traditional, SEP or SIMPLE IRA the distribution is taken from.

The individual must file IRS Form 8606 to keep track of the nontaxable (nondeductible) amounts. Form 8606 must also be filed for any year that the IRA owner takes a distribution from any of his traditional, SEP or SIMPLE IRA, so as to determine the taxable and nontaxable portion of the distribution.

It depends.

From a technical perspective, contributions include regular contributions, and Roth conversion contributions. For the purpose of this website, we use the term contribution to refer to regular contributions.

Regular contributions can be withdrawn at anytime, and will be tax and penalty free. For instance, if you made a Roth IRA contribution yesterday, and withdraw the amount today, it will be tax and penalty free. This is because no tax deduction was (or could be) permitted/allowed for the contribution. In sum, a contribution with funds that have already been taxed will be tax and penalty-free when withdrawn.

Roth conversion amounts can be withdrawn at anytime, and will be tax-free, because any taxes owed on the amount is assessed when the conversion occurs. However, the amount will be subject to the early distribution penalty, unless either of the following applies:

  • The conversion has aged for at least five years
  • The distribution occurs when the Roth IRA owner is at least age 59 ½, or
  • An exception to the penalty applies ( exceptions listed here )

Important notes:

Note # 1

Distributions from Roth IRAs are considered to occur from ‘source of funding’, in a specific order. This is referred to as the ordering rules. Under these ordering rules, distributions occur from the following sources, in the order listed:

  • Regular contributions: These can be withdrawn at anytime, and will be tax and penalty free
  • Roth Conversions: These will be tax-free when withdrawn, but will be subject to the early distribution penalty, unless the owner is at least age 59 ½ when the distribution occurs, the conversion has aged five years, or another exception applies

  • Earnings: These will be subject to tax, unless the distribution is qualified, and will be subject to the early distribution penalty-unless the distribution occurs when the owner is at least age 59 ½ or an exception applies.

Distributions occur from one category (bucket), only after amounts in the previous bucket- as listed in the ordering rules- have been exhausted. For instance, distributions can never occur from conversion amounts, until all contribution amounts have been withdrawn.

Note # 2

There are two five year-periods for Roth IRA distributions.

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