Although it's never too late to start planning for retirement, it may be too late to develop a plan that relies solely on contributions made to an individual retirement arrangement (IRA). While traditional and Roth IRAs allow you to manage retirement assets with flexibility and security, the Internal Revenue Service places limits on the amount you may contribute to an IRA. It also places limits on Roth IRA contributions for taxpayers with high incomes, and contributions to traditional and Roth IRAs are treated differently for income tax purposes.
Basic Contribution Rules
To be eligible to contribute to an IRA, you must be working and receive earned income throughout the year, and your annual contribution may not exceed your annual income. Many taxpayers may only invest $5,000 into IRAs as of tax year as of the time of publication, although the IRS doesn't set a minimum amount you may contribute each year. While you may hold any number of IRA and Roth IRA accounts, the annual contribution applies to the aggregate amount contributed to all qualifying accounts. For example, if you made a $2,500 contribution to your traditional IRA, you may only contribute up to $2,500 to your Roth or another traditional IRA account.
Age and Contributions
Because many workers don't start retirement planning when they're young, the IRS allows investors who are 50 years old or older to make additional contributions to their IRAs each year. As of the time of publication, you may invest up to $6,000 in any combination of traditional and Roth IRAs each year. This limit isn't in addition to the $5,000 allowed for younger investors, but merely a higher minimum contribution. Additionally, you must stop making contributions to IRAs when you reach your 70 1/2 birthday.
The IRS penalizes you if you make excess contributions to IRAs at a rate of 6 percent per year that the excess contribution remains in your account. For example, if you're a 35-year-old and contribute $5,000 to a traditional IRA and $2,000 to a Roth IRA, you'll be taxed for the excess $2,000, a rate of $120 per year, each tax year until you take a distribution and remove the excess amount in your account. The IRS also allows you to reallocate a previous year's excess contribution toward a future year's contribution limit. For example, if the investor who made $7,000 in contributions in one year only contributes $3,000 the following year, he no longer has to pay the penalty on the prior year's excess contribution.
Roth IRA Contributions and Income Caps
If you earn a large income, the IRS reduces or eliminates the amount you may contribute to a Roth IRA. Single taxpayers with an adjusted gross income, or AGI, less than $107,000 annually as of the time of publication may make the maximum contribution, while those who earn between $107,001 and $122,000 face reductions on their contribution limit, and those with AGIs of $122,001 or more may not contribute to a Roth. If you're married and file jointly, the maximum AGI to make full contributions to a Roth is $169,000 and couples who earn more than $179,000 may not make contributions. If you're married and file separately and lived with your spouse for any time during the year, you may only make full contributions if your modified AGI is $0, and can't contribute when your AGI exceeds $10,000.
- IRS.gov: Publication 590 - Traditional IRAs
- IRS.gov: Publication 590, Chapter 2 - Roth IRAs
- IRS.gov: 2011 Contribution and Deduction Limits - Amount of Roth IRA Contributions That You Can Make For 2011
- Bankrate.com; IRA Contribution Rules; George Saenz; February 2008
- "Kiplinger"; Roth IRA Contribution Rules; Kimberly Lankford; November 2010