An individual retirement account (IRA) is a vehicle to save for retirement. There are several types of IRAs, and they all provide substantial tax benefits. Each type of IRA has its own rules for contributions. The amount you can contribute each year varies depending on the type of IRA as well as your age, income and marital status.
Under the IRS rules governing both traditional IRAs and Roth IRAs, you can contribute up to $5,000 each year, as of 2011. Once you reach age 50, the limit increases to $6,000. You can deduct contributions to a traditional IRA from your taxable income. You don't get to deduct your contributions to Roth IRAs. However, you do not have to pay income taxes on money withdrawn from a Roth IRA after you reach age 59 1/2, as you do with traditional IRAs.
You must have earned income at least equal to the amount you contribute to a Roth or traditional IRA. To open and contribute to a traditional IRA, you must be at least 21 years old but younger than 70 1/2. After age 70 1/2, you must start taking required minimum distributions (RMDs) from traditional IRAs. These age restrictions do not apply to Roth IRAs.
The IRS sets upper income limits for contributions to IRAs. These are called phase-out rules because the amount you can contribute (for Roth IRAs) or deduct from your taxes (for traditional IRAs) is gradually reduced once your adjusted gross income reaches a given level. The amount you can contribute/deduct is phased out completely once your income hits a second, higher amount. For Roth IRAs, the phase-out amounts for 2011 are $107,000 to $122,000 for single taxpayers and $169,000 to $179,000 for taxpayers who are married and filing a joint return. For example, a single person can contribute the maximum amount to a Roth IRA if he makes less than $107,000. He can make a partial contribution if his income is between $107,000 an $122,000, and he cannot contribute at all if his income is more than $122,000. The phase-out limits for traditional IRA deductions are complicated, because they depend on whether your employer provides a retirement plan. If neither you nor your spouse is covered by such a plan, there is no phase-out. If you are covered by a retirement plan at work, the phase-out amounts are $56,000 to $66,000 if you are single (as of 2011) and $90,000 to $110,000 if you are married. If your spouse is covered at work but you are not, the phase-out amounts are $169,000 to $179,000.
SEP and SIMPLE
Simplified Employee Pensions (SEP) and Saving Incentive Match Plans for Employees (SIMPLE) are employer-provided IRAs governed by traditional IRA rules. Contribution limits are higher and phase-out rules do not apply. Your employer, not you, contributes to a SEP IRA on your behalf. Contributions are limited to 25 percent of your salary, with a maximum annual contribution of $49,000. With a SIMPLE plan, both you and your employer contribute up to 3 percent of your salary. The maximum dollar amount per year is $11,500 each, for a maximum annual contribution of $23,000. These figures are for 2011, and they can change from year to year.