What Are Individual Retirement Arrangements (IRAs)?
An Individual Retirement Arrangement (IRA) is a tax-advantaged personal savings plan designed to help individuals set aside funds for their retirement. There are several types of IRAs, with the most common being traditional IRAs and Roth IRAs. You can open an IRA through a bank, insurance provider, or other financial institution.
Traditional IRAs: Tax Benefits and Contributions
With a traditional IRA, you may be eligible to deduct all or part of your contributions, reducing your taxable income. Additionally, you might qualify for a tax credit based on your contribution amount. The funds in your traditional IRA, including any earnings, are generally not taxed until you withdraw them.
Traditional IRAs are individually owned and cannot be held jointly. However, in the event of your death, the remaining balance will be passed on to your named beneficiaries.
Contribution Rules
To contribute to a traditional IRA, you (and your spouse, if filing jointly) must have taxable compensation, such as:
Wages, salaries, tips, or commissions
Bonuses or self-employment income
There is no age limit for making contributions, but you must have earned income. Certain types of income, such as rental profits, dividends, pensions, and annuities, do not qualify as compensation for IRA purposes.
However, specific payments, including alimony, graduate study stipends, and difficulty-of-care payments, may be treated as eligible compensation.
To calculate your deduction amount, use the Form 1040 worksheets or refer to Publication 590-A. You can claim the deduction on Form 1040 or 1040-SR, attaching Schedule 1 for additional income adjustments.
If you make nondeductible contributions, you must file Form 8606.
To determine eligibility for the Retirement Savings Contributions Credit, complete Form 8880 and report the credit on Schedule 3 of Form 1040.
Distributions from Traditional IRAs
When you withdraw funds from a traditional IRA, the distributions are generally taxable.
If you made only deductible contributions, the entire withdrawal is taxed as income.
For accounts with both deductible and nondeductible contributions, use Form 8606 to calculate the taxable portion.
IRA-to-IRA Rollover Rules
You are only allowed one IRA-to-IRA rollover within a 12-month period, regardless of how many IRAs you own.
Trustee-to-trustee transfers are not considered rollovers and do not count toward this limit.
This restriction also does not apply when converting a traditional IRA to a Roth IRA.
Early Distributions and Penalties
If you withdraw funds before reaching age 59½, you may be subject to an additional 10% tax penalty, unless you qualify for an exception.
Required Minimum Distributions (RMDs)
Once you turn 73, you are required to start taking minimum distributions from your traditional IRA.
You must begin RMDs by April 1 of the year following your 73rd birthday.
Failing to take the required distributions could result in an excise tax, reported on Form 5329.
Refer to Publication 590-B for exceptions and further details.
Roth IRAs: Tax-Free Growth and Withdrawals
A Roth IRA offers a different set of tax benefits compared to a traditional IRA.
Contributions to a Roth IRA are made with after-tax dollars and are not deductible.
However, qualified withdrawals, including earnings, are tax-free.
To establish a Roth IRA, the account must be specifically designated as a Roth at the time of setup.
For details on Roth IRA contribution limits and tax rules, refer to Topic No. 309 or Publication 590-A.
Additional Information and Resources
For more details on IRA contributions, distributions, and rollovers, consult the IRS publications:
Publication 590-A – Contributions to IRAs
Publication 590-B – Distributions from IRAs