IRAs: Individual Retirement Arrangements

To be eligible for a traditional Individual Retirement Arrangement (IRA), sometimes referred to as an Individual Retirement Account, adjusted gross income and the

other types of retirement investments an individual has are the most important factors. There are also separate income limitations for investing for single tax payers and those who are married filing jointly.

Income governs IRA eligibility

The income limits set for a traditional IRA is designed to gradually phase out eligibility as an investor’s income increases. The limits are also adjusted for inflation over the next several years. For example, a single tax payer with an adjusted gross income of $50,000 is eligible to contribute the maximum amount into an IRA in 2005. As their income approaches $60,000 the amount they can contribute starts to decline until they become ineligible when it finally surpasses $60,000. Back in 2001, those income restrictions were between $33,000 and $43,000 per year.

 

Qualifying rules for married couples

Married couples filing taxes jointly can earn up to $80,000 and still contribute to a traditional IRA. That amount will increase to $100,000 by 2007. These limits are for deductible plans where funding is made with pre-tax dollars. Again, as a couple’s income approaches the high end of the adjusted gross income scales, the amount they can contribute decreases. The traditional IRA therefore targets those taxpayers in the mid-levels of earning to give them a tax deferred way to save for retirement.  Both husbands and wives can have an IRA in their name. Both parties do not have to be working, but the eligibility for making contributions has the same adjusted gross income limitations for the combined accounts. If both spouses are working, their combined adjusted gross income is considered for the purpose of eligibility.
 

Earned income is what counts

Another restriction on contributing to a traditional IRA is found in the term “earn.” Taxpayers can earn up to certain income levels and still contribute. Funding for an IRA must be from wages, self-employment income, bonuses, etc. and cannot simply be from a gift. It must be earned income or income from alimony or separation agreements.

What if you also contribute to a 401K?

If an investor already contributes to a retirement account through a company sponsored 401k plan, then the amount they can contribute to a traditional IRA is still the same. However, not all the contributions can be made with pre-tax dollars. For example, if an investor’s maximum contribution for the year is $3,000 and $2,500 has been put into a company 401k plan, then they are only eligible to contribute another $500 with pre-tax dollars. If the 401k plan has $3,000 put into it in the tax year, the maximum allowed for a tax-deferred IRA, then the investor cannot contribute further.
 

Traditional IRA or Roth IRA?

An investor should make sure they are eligible before choosing what type of IRA is the best for their needs. When setting up the account, the investment firm or bank can help determine the maximum amount that they can contribute based on adjusted gross income and the investor’s other retirement savings plans. Also choosing between how much of an IRA or Roth IRA will be funded with pre- or post-tax dollars can be determined based on what type of future expenses the investor expects.