IRA Rules

We've covered the specific rules for each type of IRA elsewhere in this publication, but we've never put all of the IRA rules together in one place. In this publication, we are going to provide a summary of these general IRA rules. This information will include eligibility, contributions, as well as rules that apply to withdrawals.

SIMPLE, Traditional, and Roth IRA Rules

We've decided on the format below because there are three types of Individual Retirement Accounts that you may be able to fund:  traditional IRAs, Roth IRAs, or SIMPLE IRAs.  The IRS has established slightly different rules for each of these retirement offerings, and this article will help to explain some of the differences between these rules.  If you need more information, then click on one of the article links appearing in the resources box.

IRA Eligibility Rules

When we talk about IRA eligibility, we're really talking about who qualifies to make a contribution to an IRA.  Most of the qualification rules are straightforward, and later on we'll discuss the answer to the question:  How much can I contribute to an IRA?

Traditional IRA Eligibility

In general, there are two eligibility rules that apply to traditional IRAs.  The first rule is that you must be under age 70 1/2 at the end of the calendar year.  The second rule states that you must have some form of compensation to contribute to a traditional IRA.  Compensation can take the form of wages, salaries, bonuses, and commissions.

Roth IRA Eligibility

The eligibility or qualifying rules for a Roth IRA are less stringent versus a traditional IRA.  To contribute to a Roth, you need some form of compensation.  There is no age limit or restriction for a Roth IRA.

SIMPLE IRA Eligibility

To participate in a SIMPLE IRA, your employer must first offer the plan to its employees.  The employer must have 100 or less employees that received $5,000 or more in compensation in the prior year.  The employer cannot offer another qualified plan, such as a 401k plan.  A SIMPLE IRA is a retirement solution for small businesses.

There is only one rule that applies to employees wishing to participate in their employer's SIMPLE IRA plan.  They must have received at least $5,000 in compensation in the past two years, and they are expected to be paid at least $5,000 in the current year.

IRA Contribution Limits

The contribution limits appearing in this section help to answer the question:  What is the maximum amount that can be contributed to an IRA?  This does not necessarily mean that an individual can contribute this much money each year.  Later on, we're going to discuss the income limits for IRAs.

Traditional IRA Contribution Rules

The IRS has spelled out two sets of rules when it comes to the maximum contributions that can be made to a traditional IRA.  The first is the "standard" contribution limit.  In 2011 and 2012, the standard contribution limit for a traditional IRA is $5,000.

In addition to the standard contribution, there is also a catch-up contribution limit.  If you've reached age 50 or older in the calendar year, then you are eligible for an additional catch-up contribution of $1,000 in 2011 and 2012.  This means your total contribution in the years 2011 and 2012 cannot exceed $5,000 + $1,000 or $6,000.

In the years 2013 and beyond, these limits will be increased with an index of inflation.

Roth IRA Contribution Rules

The maximum contribution limit for Roth IRAs is exactly the same as those for traditional IRAs.  In 2011 and 2012, the standard contribution maximum to a Roth IRA is $5,000.

If you reach age 50 or older in a calendar year, then you're entitled to take a catch up contribution.  In the years 2011 and 2012, the catch up contribution limit is $1,000.  Combining the standard and catch up limits, in 2011 and 2012 you can contribute up to $5,000 + $1,000 or $6,000.

SIMPLE IRA Contribution Rules

Employees participating in a SIMPLE IRA plan can defer up to $11,500 in 2011 and 2012.  Catch-up contributions for those 50 and older are $2,500 in 2011 and 2012.  The standard deferral contribution limits are expected to grow with the cost of living in 2012, and will apply to the 2013 values.

For more information on this topic, take a look at our detailed article on IRA Contribution Limits.

IRA Income Limit and Tax Deductibility Rules

This is where the IRS rules for each IRA type get a little more complex.  With all three types of IRAs there are income limits for contributions.  If you exceed the income limit, which is based on your modified adjusted gross income or AGI, then you are not eligible to participate, or your eligibility to make a full contribution is phased-out.

In fact, there are even phase-out limits that apply just to the tax deductibility of a traditional IRA.  At this point, it is best to direct you to more detailed articles that discuss eligibility, contributions, and income limits:

• Traditional IRA:  detailed information and tables outlining income limits, deductibility, and phase-out information for each IRS tax-filing status.
• Roth IRA Rules:  in addition to the above information, this article also discusses transfer and IRA distribution rules.
• SIMPLE IRA:  besides the eligibility and contribution rules already discussed, SIMPLE IRAs need to address portability of the account.  Just like a 401k plan, there are rules that the IRS has spelled-out concerning SIMPLE IRA rollovers.

IRA Distribution / Withdrawal Rules

For the most part, investors and retirement planners use the terms withdrawals and distributions interchangeably.  Whether you like to call it an IRA withdrawal or distribution doesn't matter.  What we are going to discuss in the following sections are the rules by which you can take money out of your IRA, as well as the possible tax penalties that apply if you don't follow these withdrawal rules.

Traditional IRA Withdrawals

With a traditional IRA, we have what is sometimes refer to as the age 59 1/2 rule.  This rule means that you have to wait until you're age 59 1/2 before you can make a withdrawal from your IRA account without incurring a 10% additional tax penalty.

Traditional IRAs also have minimum distribution (MDR) rules that begin starting at age 70 1/2.  The concept behind minimum required distributions or MDRs is quite simple.  By using a life expectancy table, you calculate how much to withdraw from your account each year such that the balance in the IRA account would be zero when you reach your life expectancy age.

Roth IRA Withdrawals

You can start to make what is called a qualified distribution after the 5th taxable year period beginning with the first year for which a contribution was made to a Roth IRA.  You need to reach age 59 1/2 to make a qualified distribution.  You can also make a withdrawal if you become disabled, or plan to use the money as a first time home buyer.

Roth IRAs are not subject to the minimum required distribution rule.

SIMPLE IRA Withdrawals

In general, SIMPLE IRAs follow the same exact withdrawal rules that apply to traditional IRAs, including exceptions.  But there is also what is called the "2-year period" rule that is unique to SIMPLE IRAs.

The 2-year period begins on the date on which the employee first participated in any SIMPLE IRA plan maintained by their employer.  Technically, this is the first day on which a contribution is made by your employer and deposited into your SIMPLE IRA fund.

If an employee takes an early distribution within this 2-year period, then the additional tax penalty is raised from 10% to 25%.  However, if one of the exceptions mentioned earlier applies to these early withdrawals, then the 25% tax penalty is not imposed.

For more detailed information on this topic, see our detailed article entitled IRA Withdrawals.

About the Author - IRA Rules

Copyright © 2005 - 2011 Money-Zine.com