Rules for Traditional and Roth IRA contributions

Both Traditional and Roth IRAs offer tax advantages for long-term retirement planning. As you compare these two options, you’ll want to understand the implications and rules for the Traditional and Roth IRA contributions.

What’s an IRA?

You may have heard the acronym IRA before, but if not we’ll walk you through what an IRA stands for. An IRA is an Individual Retirement Account — and it’s a term used to describe two types of retirement accounts: Roth and Traditional. Both have tax advantages, but have different rules and contribution limits. Individuals open IRAs to save and invest in the long term.

What’s the difference between a Roth and a Traditional IRA?

Two common types of IRAs are traditional IRAs and Roth IRAs. Earnings in these accounts can accumulate either tax-free or taxed at a later date. Also, you may be able to deduct traditional IRA contributions.

Traditional IRA rules

You can get a traditional IRA if you receive taxable compensation. This compensation includes:

• Wages, salaries, and tips
• Sales commissions
• Professional fees
• Bonuses
• Self-employment income
• Military compensation while serving in a combat zone tax-exclusion area
• Alimony or separate maintenance payments included in gross income
• Non-tuition fellowship and stipend payments included in gross income (starting with tax year 2020)

Income not included as compensation for IRA purposes includes:

• Profit from the sale of stocks or other property
• Rental income
• Pension or annuity income
• Deferred compensation

The maximum amount you can contribute to all IRAs must be the lesser of these:

• Your taxable compensation for the year
• $6,500, the maximum IRA contribution for 2023

Ex: If you earn $2,000, then your maximum IRA contribution for the year is $2,000.

The maximum amount increases to $7,500 (up to taxable compensation) if both of these apply:

• You’re age 50 or older
• You’re making catch-up contributions

When figuring your contribution limit, don’t subtract employer contributions under a SEP or SIMPLE IRA plan.

If you contribute more than allowed to your IRA, you’ll be subject to a 6% excise tax on the excess contribution. However, you will not have to pay this excise tax if you withdraw the excess by the tax return due date (plus extensions).

There’s no minimum age to participate in an IRA. If your teen-age child has compensation from a part-time job, your child can contribute to an IRA up to $6,500 (or their compensation amount if lower).

You must begin withdrawing from your traditional IRA by April 1 the year after the year you reach age 72. 

Note: The required beginning date for required minimum distributions  was recently updated to 72.

Who can deduct a Traditional IRA contribution?

These two tests determine how much of your IRA contributions are deductible:

• Active participant test
• Income test

Active participant test

The W-2 your employer sends you should show if you’re an active participant for the tax year in an employer-sponsored plan. If you’re an active participant, the Retirement Plan box should be checked.

If neither you nor your spouse were active participants in a company plan, you can deduct your traditional IRA contributions regardless of how high your income is.

IRA income test

If you’re covered by a company plan, a second test decides how much of your IRA contribution you can deduct. If you’re an active participant in a company plan, the traditional IRA deduction for 2022:

• Begins to phase out when your modified adjusted gross income (AGI) reaches $68,000 if you are single or head of household, or $109,000 if married filing jointly.
• Is phased out completely when your income is more than $75,000 if you are single or head of household, or $129,000 if married filing jointly.
• The phase-out range increases to $204,000 — $214,000 for a spouse that is not an active participant when the other spouse is an active participant in a company plan.

If your modified AGI is equal to or less than the lower phase-out amount, you can deduct your full IRA contribution. This is true even if you’re an active participant in a company plan. For these purposes, your modified AGI is your AGI with these items added back:

• Traditional IRA deduction
• Student-loan interest deduction
• Foreign earned-income exclusion
• Foreign-housing exclusion or deduction
• Excluded U.S. Savings Bond interest
• Excluded employer-provided adoption benefits

If you and your spouse file separate returns, the phase-out range is $0-$10,000. So, you can’t claim the IRA deduction if your modified AGI is more than $10,000.

You’re considered unmarried for purposes of the IRA deduction limitation if you’re married but:

• You didn’t live with your spouse at any time during the year.
• You and your spouse filed separate returns.

If your income is too high to deduct contributions to a traditional IRA, you might qualify for a Roth IRA. However, contributions to a Roth IRA aren’t tax deductible. Roth IRA contributions are still a long-term investment in a retirement savings plan.

Roth IRA rules

Roth IRAs are subject to the same rules as traditional IRAs. However, there are some exceptions:

• You must designate the account as a Roth IRA when you start the account.
• Earnings in a Roth account are tax-free rather than tax-deferred. You can’t deduct contributions to a Roth IRA. However, the withdrawals you make during retirement can be tax-free. They must be qualified distributions.
• You can withdraw contributions at any time without tax or penalty.
• You can continue to make contributions after you reach age 72. However, you must still receive taxable compensation.
• You don’t have to begin taking withdrawals at age 72.
• The balance in your account when you die generally goes to your heirs tax-free. The account has to have been open and contributed to for at least five years.

Who can contribute to a Roth IRA?

Higher-income people who actively participate in company retirement plans can’t deduct traditional IRA contributions. However, you can still contribute to save on a tax-deferred basis for retirement.

The amount you can contribute to a Roth IRA 2022:

• Begins to phase out when your modified AGI reaches $129,000 if you are single or head of household, or $204,000 if married filing jointly
• Is phased out completely when your income is more than $144,000 if you are single or head of household, or $214,000 if married filing jointly

These levels apply even if you’re not covered by a company pension plan.

Married couples filing separately can’t make Roth IRA contributions if both of these are true:

• Your modified AGI is more than $10,000
• You lived together at any time during the year

Spousal IRAs

If you’re married and one spouse doesn’t receive compensation or makes less compensation, you can open an IRA account for the spouse making less taxable compensation than the other spouse. You can contribute up to the maximum for each spouse, as long as you don’t exceed the total compensation received by both spouses [on a married filing joint return]. When both spouses are age 50 or older, the limit is $7,500 per spouse.

Choosing your IRA trustee

You must contribute to your IRA through a trustee or custodian the IRS approves. However, you’ll always have complete control over the investments in your IRA.

You can contribute to your IRA through any of these IRS-approved trustees:

• Bank, savings and loan, or insured credit union — your investment is likely to be held in one of these:
  • Certificates of deposit
  • Money-market accounts
• Mutual-fund company — Your retirement money might be professionally managed in one of these:
  • Portfolio of stocks or bonds
  • Money-market fund
• Insurance company — Your money might be invested in fixed or variable annuities
• Brokerage firm — You might have a self-directed account that offers flexibility. These IRAs allow you to choose the exact types of investments you want in your IRA. You must have a self-directed account to invest in:
  • Gold or silver coins
  • Real estate investment trusts
  • Limited partnerships

Some IRA accounts have annual fees, while others have no fees.

You can have many IRA accounts. You can:

• Contribute to a single traditional IRA or Roth IRA account each year
• Open a different account each year
• Divide each year’s contribution among several accounts
• Divide your contribution between a traditional IRA and a Roth IRA

However, by having more than one account, you might also pay multiple trustee and bookkeeping fees.

No matter how many accounts you have, your total annual contributions can’t be more than the maximum allowable limit.

Due date for IRA contributions

The last day to make your IRA contribution each year is the day your return is due for the year, not including extensions. You can mail your IRA contribution, and you’ll meet the deadline if it’s postmarked by the original due date for filing Form 1040.

IRA recordkeeping

If you have contributed to a nondeductible traditional IRA, you must keep track of your basis. By doing so, you can make sure you won’t pay tax on the money again when you withdraw it.

Basis is usually the combination of these:

• Total amount of nondeductible IRA contributions you’ve made
• Basis from after-tax amounts in qualified retirement plans you’ve rolled over to your traditional IRA accounts

You must file Form 8606 for any tax year you made a nondeductible IRA contribution. You can also use Form 8606 to help you track your total IRA basis. You might have a traditional IRA with basis from nondeductible contributions or rollovers. If so, you’ll need to calculate the taxable portion of any withdrawals.

You might receive both taxable and nontaxable distributions. If so, use Publication 590-B worksheets to help you figure the taxable portion of your IRA withdrawals. You’ll report the taxable and nontaxable portions of the distributions on Form 8606.

IRA rules – Moving your money around

You don’t have to keep your IRAs in the same accounts from your contribution date to your retirement date. You can move your money around to take advantage of changes in the market or in your investment philosophy.

However, you must follow certain rules. Some financial institutions might impose early withdrawal penalties on investments (Ex: CDs and annuities). They can do this even though you roll over the investments. If you do a direct rollover, you won’t pay an IRS penalty.

Converting your Traditional IRA to a Roth IRA

Moving money from your traditional IRA to a Roth IRA is called a conversion. If you don’t have basis in your traditional IRA, the entire amount will be included in your income. Otherwise, the amount included in income is calculated as if you were taking a withdrawal from traditional IRA. You can convert funds from your traditional IRA to a Roth IRA regardless of your income.

One method of conversion is to take a distribution from the traditional IRA and contribute it (rollover) into a Roth IRA within 60 days from the date of distribution.

Contributing too much to an IRA

If you make excess IRA contributions, you’re subject to a 6% tax.

The penalty applies each year until you either:

• Withdraw the excess
• Use the excess as a future year’s contribution

If you withdraw the excess amount plus any related earnings before the due date, including extensions:

• You won’t be subject to the penalty on the excess contribution
• You’ll pay tax on the earnings

Roth or Traditional IRA help

If you’re seeking investment guidance, consult a certified financial planner. For tax guidance around investments, find an H&R Block tax office location nearest you.