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IRA Rules – So that each individual can best plan for financial security and stability during his retirement there are various types of Individual Retirement Account (IRA) plans. Some of the most common IRA plans include Traditional, Roth, Self Directed and SIMPLE IRA. There are different rules with regards to Eligibility (who can participate), Contribution Limits (maximum amount that can be contributed), Income Tax Deductions, Withdrawal and Rollover / Transfer that governs these plans. We will discuss each of these rules for various IRA plans.

Eligibility – IRA Rules

  1. Traditional IRA
    For you to be eligible to contribute to a Traditional IRA you just need to have enough earned income to make the contribution and not have reached the age of 70.
  2. Roth IRA
    In case of a Roth IRA the rules are less restricting than those of a Traditional IRA. Anybody having some form of compensation can participate in a Roth IRA, without any restrictions related to age.
  3. Self Directed IRA
    Anyone is eligible to set up a self directed IRA, however self directed IRA’s are subject to more complicated regulations (depending on what the account is invested in) and not every IRA custodian has the expertise necessary to administer such an account. Also, most custodians do not offer the ability to have true checkbook control of a self directed IRA. This is important if you wish to take advantage of many alternative types of investments.
  4. Simple IRA
    Any employer who has employed 100 or fewer employees is eligible to set up a SIMPLE (Savings Incentive Match Plan for Employees) IRA. Not all employees are eligible to contribute to a SIMPLE IRA. Only those employees who, in any of the preceding two years, have earned at least $5,000 in compensation and are also expected to receive at least $5,000 during the current calendar year are eligible to participate in a company’s SIMPLE IRA plan.

Contribution Limits

  1. Traditional IRA
    Under a traditional IRA, contribution limits have been defined by the participant’s age. If you are below 50, the “standard” contribution limit in 2023 is $6500. Those who are above 50 are allowed an additional catch up contribution of $1000. Thus those plan participants who are above 50 can contribute up to $7500.
  2. Roth IRA
    Exactly like the traditional IRA, the maximum contribution limits for a Roth IRA are the same. For the year 2023, contributions cannot exceed $6500, if you are below 50. Participants above 50 can contribute an extra $1000 (catch-up contribution). The actual contribution that an individual can make would depend on his filing status (single, married and filing jointly, married but filing separately) and the income level. A taxpayer can contribute as much as he could under a traditional IRA subject to the fact that his Modified Adjusted Gross Income (MAGI) is below a certain level. The amount of contribution that is permitted in a Roth IRA is reduced proportionately as one reaches the top end of the allowed range. As MAGI cross the top of the range, no contribution is allowed at all.

    The Roth IRA MAGI phase out range for 2023 is:

    • Single filers with income up to $138,000 will qualify for a full contribution,
    • Joint filers with income up to $218,000 qualify for a full contribution while contribution limits will decrease proportionately if income level touches $228,000. No contribution is allowed if income exceeds $228,000.
    • If you are married and filing separately and have stayed with your spouse at any time during the year, you may contribute $6500 if your MAGI is $0, while the contribution will decrease proportionately as your MAGI touches $10,000. If MAGI > $10,000, you can contribute to Roth IRA.
  3. Self Directed IRA
    Contribution levels for self directed Traditional or Roth IRA’s are the same. The fact an IRA is self-directed does not affect the contribution levels.
  4. Simple IRA
    The SIMPLE IRA contribution limits for 2023 are a lot more different from the standard IRA contribution rules. These are two types of contribution that are made to a SIMPLE IRA:
    • Contribution by employees out of salary – The maximum value that an employee is permitted to contribute to a SIMPLE IRA plan in 2023 is $15,500. Like in Traditional IRA, those employees who are above 50 years in age are allowed a catch up contribution. The SIMPLE IRA limit for catch up contributions in 2023 is $3500.
    • An elective or non-elective matching contribution by employer – Employers can choose between non-elective or matching contributions. The employer has to inform the eligible employees every year on which method of contribution will be in place for that year. Employers can make matching contributions up to 3 percent of the employee’s participation level. Employers have the option to reduce the matching contribution from 3 percent salary to 1 percent of salary. But the employer cannot contribute less than 1 per cent. Employers are also not permitted to reduce the 3 percent salary limit beyond 2 full years out of the 5 year time span that ends during the calendar year where the reduction is in place.

In case of opting for non-elective contributions, employers are required to make the 2% of the eligible employee’s salary as contribution, irrespective of whether or not an employee participates in salary deductions. For the purpose of determining the contribution, the upper salary limit to consider is set at $330,000 for 2023.

Income Tax Deductions

  1. Traditional IRA
    Not all contributions made into a Traditional IRA would be allowed for a tax deduction. The income tax deduction allowed depends on your filing status and income level. Below are limits which if applicable will decrease or entirely prevent a tax deduction.
    • If you are married and filing jointly with your spouse or if you are a qualified widow the annual income limits allowed for tax deduction are $116,000 and $136,000.
    • If you are married and filing jointly and you were not covered by an employee sponsored plan, but your spouse was, the income limits allowed for tax deduction are $218,000 – $228,000.
    • If you are a single filer, the income limits allowed for tax deduction are $73,000 – $83,000.
    • If you are married, but filing separately the annual income limits allowed for tax deduction are $0 – $10,000.
  2. Roth IRA
    Contributions to a Roth IRA are made out of post tax earnings and hence there is no tax deduction that is available for contribution.
  3. Self Directed IRA
    With regard to tax deduction on contribution, there are no unique rules for self directed IRAs and the rules applicable for traditional IRAs apply to self directed IRA.
  4. Simple IRA
    The contributions made by Employees through payroll deductions into a SIMPLE IRA are eligible for a tax deduction and the investments in the account can grow tax-deferred until withdrawn at retirement.

Withdrawal / Distribution

  1. Traditional IRA & Self Directed IRA
    Once you reach the age of 70 ½, you will have to start taking withdrawals from the IRA. These are called RMD’s or Required Minimum Distributions. Taking a withdrawal is not a matter of choice, but is mandatory. There is a formula that fixes the minimum mandatory withdrawal amount. If you do not take the required withdrawal, the IRS will confiscate half of the mandatory amount automatically.
    If you have not reached the age of 59 ½ and you still want to take a withdrawal, besides the tax, you would be charged a penalty of 10 per cent. There are some waivers which might allow you an exemption from the penalty. A few conditions under which you are allowed an exemption from penalty are withdrawals for first time home purchase (up to $10,000), higher education expenses, death, disability, un-reimbursed medical expenses, health insurance, annuity payments and payments of IRS levies.

  2. Roth IRA
    Contributions to a Roth IRA may be withdrawn tax-free at any time – it is a return of already taxed principle. Roth conversions – if you convert a traditional IRA into a Roth IRA, you will pay income taxes based on the converted amount. Also, there is a five-year “seasoning” period. If you are under 59 ½ and take a distribution during this five-year seasoning it will be subject to the 10% IRS penalty. Distributions will normally be from contributions, then conversions and finally earnings.
  3. Simple IRA
    More or less the distribution rules that apply to Traditional IRA also apply to SIMPLE IRA. Some minor differences that exist are related to early withdrawal.
    If a participant under the age of 59 ½ wishes to take a distribution and it has been less than two years since their first contribution into the plan, they could be penalized up to 25% (10% if more than two years) by the Internal Revenue Service.

Transfer / Roll-Over Rules

A rollover is a tax-free distribution from one retirement plan to the other. These are the rules governing roll-overs which you need to know:

  1. Traditional IRA & Self Directed IRA
    Funds from a traditional IRA can be rolled over to all other retirement plans except to SIMPLE IRA and designated ROTH account (401k, 403b, 457b).
  2. Roth IRA
    You are not permitted to rollover funds from a Roth IRA to any other retirement account.
  3. Simple IRA
    Like a traditional IRA, you can receive a roll-over into a SIMPLE IRA from any other retirement account except a designated ROTH account (401k, 403b, 457b). The difference being that rollovers can be received only after completion of first 2 years since the employee first participated or contributed in the SIMPLE IRA plan. The 2 year rule also applies to roll-over contributions made out of SIMPLE IRA. Funds from a SIMPLE IRA can be rolled to any other IRA only after 2 years since the employee first participated in the plan.

At SD Retirement Plans, we can help you understand the IRA rules and help you realize the full potential of your IRA account.

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