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Traditional IRAs: Contributions
Funding an IRA
A Traditional IRA can be funded by several sources and means:
- IRA participant contributions
- spousal IRA contributions
- transfers
- rollover contributions
IRA Participant Contributions
On an annual basis, an individual may contribute 100% of compensation up to the following amounts:
| Tax Year |
Regular Contribution Limit |
Tax Year |
Additional Catch-Up Contribution Limit |
| 2005 |
$4,000 |
2005 |
$500 |
| 2006 |
$4,000 |
2006 |
$1,000 |
| 2007 |
$4,000 |
2007 |
$1,000 |
| 2008 |
$5,000 |
2008 |
$1,000 |
| 2009 and after |
$5,000 |
2009 and after |
$1,000 |
Beginning 2009, contributions are indexed
for cost-of-living adjustments (COLA)
increases in $500 increments. |
Catch-up contributions are not indexed for inflation. |
| Table 1: Traditional IRA Contributions Limits |
Individuals who are age 50 and older by the end of the year for which the contribution applies can make additional catch-up contributions. For instance, an individual who is under age 50 may contribute up to $4,000 for tax year 2007, but an individual who is age 50 or older may contribute up to $5,000.
All IRA participant contributions must be made in cash (which includes checks). This means an IRA participant cannot make contributions in the form of securities.
Spousal IRA Contribution
An individual may establish and fund a contribution on behalf of his or her spouse who makes little or no income. Spousal IRAs are subjected to the same rules and limits as that of regular Traditional IRA participant contributions. The spousal IRA must be held separately as IRAs cannot be held as joint accounts.
For an individual to be eligible to establish a spousal IRA, he or she must meet the following requirements:
- The couple must be married and file a joint tax return.
- The individual making the spousal IRA contribution must have eligible compensation.
- The total contribution for both must not exceed the taxable compensation reported on their joint tax return.
- Contributions to one IRA cannot exceed the contribution limits detailed in the above chart.
Transfers
A transfer is a non-reportable, nontaxable movement of assets between similar types of retirement plans.
An IRA owner may transfer assets between Traditional IRAs and SEP IRAs or from SIMPLE IRAs to Traditional and SEP IRAs. Generally, assets are transferred for the purpose of consolidating assets or changing financial institutions.
A transfer of IRA assets may also be made from one spouse's (or former spouse's) IRA to another, providing the transfer is permitted in accordance with a divorce decree or a legal separation agreement.
There is no limit on the number of times an IRA holder may transfer assets between IRAs.
SIMPLE IRA assets cannot be transferred to a Traditional IRA or a SEP IRA until two-years after the employer first made a contribution to the individual's SIMPLE IRA.
Rollovers
An individual may make rollover contributions to his or her Traditional IRA. A rollover is a tax-free movement of assets between retirement plans, but unlike a transfer, the transaction is reportable: the distribution is reported to the IRS and the IRA owner on IRS Form 1099-R, and the contribution on IRS Form 5498. An IRA owner may complete one rollover contribution per IRA within a 12-month period.
A rollover contribution may originate from the following:
- A distribution from the same Traditional IRA, another Traditional IRA, a SEP IRA or a SIMPLE IRA that meets the two-year requirements. Rollover contributions must be made within 60 days after the IRA holder receives the distributed assets.
- A direct rollover or rollover from a qualified plan, 403(b) plan or a governmental 457 plan. There is no time limit for depositing assets representing a direct rollover.
Deducting IRA Contributions
An individual may be able to get a tax deduction for his or her IRA participant contribution. The ability to deduct a Traditional IRA contribution is determined by the following:
If allowed a deduction, the individual, depending on the above, will be permitted a full or partial deduction. We summarize how the above factors determine deductibility in Table 2 below.
Active Participant Defined
Generally, active-participant status depends on whether or not the IRA owner participates in an employer-sponsored retirement plan, which includes the following:
- qualified plans, such as profit-sharing plans, defined-benefit plans, money-purchase pension, target-benefit plans and 401(k) plans
- SEP IRAs
- SIMPLE IRAs
- 403(b) plans
- qualified annuity plans
- employee-funded pension trusts (created before June 25, 1959)
- plans established for employees by the United States, a state or political subdivision of the United States, or an agency or instrumentality of the United States or any of its subdivisions
The rules for what defines an active participant vary among the different plans. For example, an individual is considered an active participant in a profit-sharing plan for the same year in which his or her employer deposits the contribution to the employer's profit-sharing account, even if the contribution is being made for a different year.* This is not so for a money-purchase pension plan. With this type of plan, the individual is considered an active participant for the year for which the contribution is made, regardless of when it was deposited.
* Employers have until their tax-filing deadline plus extensions to make contributions; therefore, a contribution for 2007 may be made in 2008.
Usually, the employer will indicate, by checking the "Retirement Plan Box" on the individual's Form W-2, whether the individual is an active participant for the relevant year. Individuals should check with their employers to be sure.
Table 2 below summarizes the deductibility limits for Traditional IRA contributions made for tax year 2005. For subsequent years, the rules for partial or full deductibility do no change, but the some of the limits on modified adjusted gross income will change each year until 2007. We summarize these changes in Table 3 as they have occurred since 2003.
Because the rules differ for each spouse when one is an active participant, use the chart from the perspective of the individual for whom you are trying to determine deductibility. For instance, if an individual is not an active participant and files a joint tax return with a spouse who is an active participant, the individual is able to deduct the entire amount contributed to his or her Traditional IRA, but the spouse might not be able to deduct his or her own contribution. In this case, the ability to deduct each spouse's IRA contribution is determined by his or her modified adjusted gross income.
Tax-Filing Status
|
Active Participant Status
|
Modified Adjusted Gross Income
|
Deduction Allowed
|
Single or Head of Household
|
Individual is not active |
No Limit |
Full Deduction |
| Individual is active |
$52,000 or less |
Full Deduction |
| More than $52,000 but less than $62,000 |
Partial Deduction |
| $62,000 or more |
No Deduction |
Married Filing Jointly
|
- Individual is not active
- Individual's spouse is not active |
No Limit |
Full Deduction |
| Individual is active |
$83,000 or less |
Full Deduction |
| More than $83,000 but less than $103,000 |
Partial Deduction |
| $103,000 or more |
No Deduction |
- Individual is not active
- Individual's spouse is active |
$156,000 or less |
Full Deduction |
| More than $156,000 but less than $166,000 |
Partial Deduction |
| $166,000 or more |
No Deduction |
Married Filing Separately
|
- Individual is not active
- Individual's spouse is not active |
No Limit |
Full Deduction |
| Individual is active* |
$10,000 or less |
Partial Deduction |
| $10,000 or more |
No Deduction |
- Individual is not active
- Individual's spouse is active** |
$10,000 or less |
Partial Deduction |
| $10,000 or more |
No Deduction |
| Table 2: Traditional IRA Deductibility Limits for 2007 |
* If the individual and his or her spouse did not live together at any time during the year, the individual is considered 'single' for tax-filing purposes and should use the guidelines for a single taxpayer.
** If the individual and his or her spouse did not live together at any time during the year, the individual is allowed a full deduction.
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Example 1
John is not an active participant, and he files a joint tax return with his spouse, Mary, who is an active participant. They are able to claim a full deduction for John's IRA contribution if their modified adjusted gross income is less than $156,000. However, they can claim a full deduction for Mary's IRA contribution only if their modified adjusted gross income is $83,000 or less. |
Figuring the Deductible Amount
Individuals whose incomes fall within the phase-out ranges can partially deduct contributions made to a Traditional IRA. The following formula determines the amount of the contribution that is deductible:
Example 2
Jack and Jill are married and file a joint tax return for 2007. Jack is an active participant, but Jill is not. Their modified adjusted gross income is $88,000, which falls into the $83,000-to-$103,000 phase-out range, so the highest and lowest dollar limit for this range is $103,000 and $83,000 respectively. Jack is under age 50 and is therefore able to contribute $4,000 to a Traditional IRA. Using the formula above, Jack calculates his maximum deductible amount:
= ($103,000-$88,000) x [$4,000 / ($103,000 - $83,000)]
= $15,000 x ($4,000 / $20,000)
= $15,000 x 0.2
Answer =$3,000
Note: Calculations are rounded up to the nearest $10. For instance, a calculation that results in $555 would be rounded up to $560.
Jack has the following options for the $3,000:
- deduct the $3,000
- treat it as a nondeductible contribution
If Jack treats the amount as a nondeductible contribution, he will not pay income tax on the amount when it is distributed from the IRA. |
Tax-Filing Requirements
Individuals who make nondeductible contributions to their Traditional IRAs must file IRS Form 8606 for the year the nondeductible contribution is made. Failure to file Form 8606 may result in a $50 penalty and may cause all the contributions to be treated as deductible and therefore subject to taxes upon distribution (generally, a distribution of nondeductible contribution is not subjected to income tax).
Permissible Investments in IRAs
One benefit of investing in an IRA is that the investment options are many and varied. There are relatively few investments that are not permitted in an IRA. The ability of the IRA owner to choose the type of investment depends on the IRA product and the financial institution. Some IRAs may be limited to a pre-selected core group of investments or a specific investment while, for other IRAs, the IRA owner is free to choose the investments. These are commonly referred to as "self-directed IRAs" (SDAs).
Permissible investments for IRAs include stocks, bonds, mutual funds, real estate, some coins and money market funds.
Investment in Collectibles
IRAs cannot invest in collectibles, which include art works, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages and certain other tangible personal property. The one exception is that IRA assets can invest be invested in U.S. gold coins, silver coins minted by the Treasury Department, certain platinum, gold, silver, palladium and platinum bullion. Volume limitations apply.
Some financial institutions place further restrictions on IRA investments.
Next: Traditional IRAs: Distributions
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