History of IRA's
With the passage of ERISA (Employee Retirement Income Security Act of 1974), certain individuals were allowed the opportunity to begin a personal retirement plan, technically referred to as an Individual Retirement Arrangement. An IRA can either be in the form of an Individual Retirement Account or an Individual Retirement Annuity. Most IRA's are under the category of Individual Retirement Accounts, in which an investor can hold a number of different types of instruments, such as stocks, bonds, CD's, and mutual funds. At first, all contributions to IRA's were fully tax-deductible, although not all taxpayers were eligible to contribute. For example, beginning with tax year 1975, individuals who were not covered by a retirement plan through their employer could make a tax-deductible contribution of up to $1,500 into an IRA. Subsequent legislation has increased the limit to $2,000 per year, and has also revised the rules regarding the deductibility of IRA contributions. Recent legislation has also created different types of IRA's. In this article, we will focus on Traditional IRA's, Roth IRA's, Spousal IRA's, and Rollover IRA's.

Traditional IRA's
With a Traditional IRA, an individual can contribute the lesser of up to 100% of compensation or $2,000 per year. In order to qualify for this type of IRA, an individual must have compensation or "earned income," which includes wages, salaries, commissions, fees, tips, bonuses, alimony, and self-employment income. Compensation does not include "passive income," such as deferred compensation, pension income, investment income, rental income, or disability income. In other words, it must be received from personal services currently rendered. Having met the compensation requirement to contribute to a Traditional IRA, the taxpayer's age must also be considered. Contributions can be made until the year the individual attains age 70½, which is when distributions from a Traditional IRA must begin.

It is a common misconception for an investor to think they cannot contribute to an IRA because their income is "too high." That may have been the case when IRA's first became available in the 1970's, but the current IRS regulations allow anyone who meets the above requirements regarding age and compensation to contribute. The question that must be considered is whether it will be a tax-deductible contribution. Generally, as long as an individual is not covered by a retirement plan through an employer at any time during the tax year, the contribution is fully deductible, regardless of income level. However, if the individual's spouse is covered by an employer-sponsored retirement plan, the contribution cannot be deducted if their joint adjusted gross income is over $160,000. A partial deduction is allowed in the AGI range between $150,000 and $160,000. A single tax filer covered by a retirement plan through an employer can deduct their Traditional IRA contribution as long as their AGI is under $32,000 for the year 2000. A partial deduction is allowed if their AGI is between $32,000 and $42,000.

Earnings in a Traditional IRA grow tax-deferred, which means they will not be taxed until withdrawn, generally at retirement. For this reason, an individual who does not qualify for a tax-deductible contribution may still want to consider making a non-deductible contribution to a Traditional IRA. This is especially so if they do not qualify to contribute to a Roth IRA. They can still reap the benefits of tax-deferred growth on their investment.

Roth IRA's
Roth IRA's first became available in tax year 1998, in which an individual could make non-deductible contributions up to $2,000. Although the opportunity for a current tax write-off is not a feature of the Roth, the advantage of the Roth IRA is that earnings on the contributions are tax-free at retirement, not just tax-deferred as in the Traditional IRA.

To be eligible to make a Roth contribution, an individual must meet the same compensation requirements as with a Traditional IRA. However, there is no maximum age limit. If a person 70½ or older still has earned income, they could make a Roth contribution, but at that age level the IRS would not permit them to contribute to a Traditional IRA. However, an individual's income cannot be what the IRS would consider too high for the purposes of Roth eligibility. A single filer can contribute $2,000 to a Roth IRA if their adjusted gross income is under $95,000; their ability to contribute to a Roth phases out at an AGI range of $95,000 to $110,000. For married couples, their joint AGI must be below $150,000 for each person to contribute a full $2,000, and their eligibility phases out between $150,000 and $160,000. Being covered by an employer's retirement plan does not affect an individual's Roth eligibility in any way.

An individual can also take an existing Traditional IRA and convert it to a Roth IRA as long as their adjusted gross income is under $100,000 (not including the amount being converted). They would be subject to ordinary income taxes on the amount converted during that tax year, but any earnings from that point forward would be tax-free at retirement.

Married couples filing separately are significantly limited in their ability to take advantage of the Roth IRA's benefits. To contribute to a Roth, the separate filer's AGI must be under $10,000. In addition, those who are married filing separately are not allowed to convert a Traditional IRA to a Roth IRA.

It is critical to remember that the limit for contributing to an IRA is $2,000 per person, not $2,000 per IRA type. However, it is permissible for an individual to split up to the $2,000 limit between different IRA types. For instance, if an individual can only contribute $800 to a Roth because of their income level, they can contribute up to $1,200 to a Traditional IRA as well, regardless of whether it is deductible or non-deductible.

Spousal IRA's
With either the Traditional IRA or Roth IRA, the IRS has made a provision for a non-earning spouse to make a contribution of up to $2,000 per year, provided that one spouse earns at least $4,000 for each to contribute the maximum. In prior years, the non-earning spouse was limited to $250, so recent legislation has greatly benefited their ability to save for retirement. It is not required that both spouses contribute to the same type of IRA. For example, the husband could contribute to a Roth and the wife could contribute to a Traditional IRA. This possibility could warrant some careful tax planning if one spouse qualifies for a tax deduction in a Traditional IRA, and the other spouse does not.

Rollover IRA's
The types of IRA's discussed so far are considered contributory IRA's, where an individual contributes their own funds to a retirement account, but another IRA type is a Rollover IRA or a "conduit IRA." Generally, a Rollover IRA is a traditional IRA that has received funds from an employer-sponsored qualified plan or 403b plan, which the IRA investor may in the future opt to roll back to another employer's retirement plan. In order to exercise this option, the funds rolled over into the conduit IRA must be kept separate from Traditional IRA accounts that originated with the individual's own IRA contributions. Some investors may choose to combine their Traditional IRA with their rollover money (often referred to as "commingling"), which is permissible, but they then lose the option to roll the funds back to an employer's retirement plan in the future. It is important to be aware of the consequences to the investor of such an action. A Rollover IRA can also be converted to a Roth IRA if the individual qualifies to do so, but again, with this action the ability to roll the money back to a future employer's retirement plan is lost. Since the Rollover IRA consists of pre-tax funds, converting it to a Roth IRA would be fully taxable.

The Rollover IRA category should not be confused with doing a 60-day rollover, where an individual can move the funds from one IRA to another IRA in a 60-day period.

Pending legislation in Congress may significantly change many rules regarding IRA's, such as increased annual contribution limits, broader eligibility for deductions on Traditional IRA's, simplifying the rules for minimum required distributions at age 70½ from Traditional IRA's, and "catch-up" provisions for individuals age 50 and over. Stay tuned to this website for updates!