Depending on the type of IRA, different rules are applied. Because traditional and Roth IRAs provide a different mix of advantages, it’s important to know the various rules for maximizing contributions inside your IRA. Here are the things you need to know about the traditional IRA rules.
Traditional IRA Rules | 7 Things You Must Know
First and foremost, anyone who has an earned income can contribute to a traditional IRA as long as they are not over 70 ½ years old. (This is also the age at which you receive your first minimum required distributions or RMD.) With a traditional IRA, you can invest your money in different ways.
In terms of growing your retirement account, one of the traditional IRA rules is to place your contributions in the following investments:
- Mutual funds
- Lifecycle funds
You can also invest certain kinds of gold coins and other precious metals through your self-directed IRA. To make an investment, you will work with IRA banks and brokerages.
However, this rule has exceptions. You cannot invest in life insurance or collectibles, such as:
3. IRA Contribution Limits
Since 2015, the IRS has limited your total contribution to the following:
- $5,500 (with a catch-up contribution of $1,000 for those 50 years old and above); or
- Your annual taxable compensation, if it was less than the limit, in dollars
With the exception of:
- Qualified reservist repayments
- Rollover contributions
Note: The traditional IRA rules state that if you exceed the allowed amount for contribution, you will owe a 6% tax on the total amount exceeded. If you have a non-deductible traditional IRA, these limits still apply to you.
4. Tax-Deductible Contributions
The tax deduction on your contribution depends on your income, as well as on whether you or your spouse have an employer-sponsored retirement plan, such as a 401(k).
On the other hand, taxable income includes:
- Salaries and wages
- Income from self-employment (through simple IRA)
- Non-taxable combat pay
- Alimony and separate maintenance
With the exception of:
- Property profits and earnings
- Deferred compensation
- Income from interests and dividends
- Income from partnerships
- Pension or annuity income
5. Tax Incentives
Although there are differences between Roth and traditional IRAs, they both provide generous tax breaks. However, claiming them is a matter of finding the right time.
Traditional IRA rules say:
- Contributions are tax-deductible on federal and state returns for the year of contribution.
- Withdrawals in retirement are taxable, based on ordinary income tax rates.
Note: Like a Roth IRA, there are no taxes to pay for traditional IRAs for the growth of your contributed funds, provided they remain in the account.
6. Traditional IRA Withdrawal
There is no penalty for withdrawals by investors age 59 ½ and up. If you want to withdraw before you reach that age, the IRS will consider your withdrawal to be taxable income. On top of that, you will have an additional early withdrawal penalty of 10%. However, there are several exceptions to this rule, including:
- medical expenses
- certain educational expenses
- first-time home purchase
- other special situations
7. Extra Benefits
Your contributions lower your taxpayer’s adjusted gross income (AGI), which can potentially make you, as the investor, eligible for other tax incentives such as:
- Maximum of $10,000 withdrawals with no penalty, which can cover expenses for buying a house for the first time (taxes due on IRA distributions)
- Qualified education and hardship withdrawals
Because there are different types of IRAs, the incentives can vary. Based on the traditional IRA rules, you can get tax deductions, extra benefits, and tax incentives. These all depend on your eligibility, income, and contribution.
Are there other traditional IRA rules you know? Share them with us in the comments section below!
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This post was originally published on September 18, 2017, and has been updated for quality and relevancy.