IRA Rules: 8 Things You Need to Know

June 22, 2022
When you're ready to choose an IRA, one of your first tasks is to figure out how the rules for each type of IRA line up with your personal situation.

Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)

Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)

It's especially important to understand how each type of IRA works when it comes to things like contributions, tax deductibility, and withdrawals, since these features can affect your finances now and down the road.

For example, maybe you're on a tight budget but want to start saving for retirement as soon as possible. 

"In that case, the potential up-front tax deduction that a traditional IRA offers could help you save more now and get a head start," says Rob Williams, managing director of financial planning, retirement income, and wealth management for the Schwab Center for Financial Research. 

Or maybe you expect to be in a higher tax bracket when you retire and could benefit more from tax-free withdrawals and the option to leave your savings to a loved one tax-free. According to Rob, that could mean a Roth IRA makes more sense for you. But in both cases, you'll need to meet certain requirements to get the benefits.

Rob says, "The best IRA for you, if any, depends heavily on your specific situation and goals—in other words, which type of IRAs you qualify for and what you're trying to achieve with your IRA account." 

Here are eight key facts to help you make an IRA decision that's right for you.

1. You can contribute to an IRA, even if you have a 401(k)

If you or your spouse contribute to an employer-sponsored retirement plan, such as a 401(k), 403(b), or 457 plan, you can still open an IRA. With a Roth IRA, you'll need to meet the income limits to contribute. With a traditional IRA, you can contribute as long as you have earned income, but you'll need to meet income limits to get a tax deduction.

2. Your income could be too high for a Roth IRA

Higher income levels can reduce the amount you're allowed to contribute to a Roth IRA or make you ineligible for the year. If you're a single filer, for instance, your modified adjusted gross income (MAGI) must be below $129,000 for 2022 to contribute the maximum amount. And partial contributions phase out once your MAGI reaches $144,000. Married couples filing jointly must have a MAGI below $204,000 for 2022 to contribute the maximum amount, with partial contributions phasing out at $214,000.

3. If you don't have a retirement plan at work, traditional IRA contributions are fully deductible

This applies to individuals and couples with no employer-sponsored account, but couples must file a joint tax return to get the deduction. Couples may qualify for a partial deduction if only one spouse has a plan at work. If you're single and have a plan at work, or you and your spouse both have plans at work, the amount you can deduct depends on your income. For example, single filers must have a MAGI of $68,000 or less to take the full deduction for 2022. Single filers with a MAGI between $68,000 and $78,000 can get a partial deduction. And those with a higher MAGI can still contribute but won't get a deduction on their 2022 taxes.

4. Roth IRA contributions aren't tax deductible, but you can take money out tax-free

Roth IRAs may offer more flexibility than traditional IRAs when it comes to withdrawing your money. You can withdraw your contributions anytime for any reason. And once you turn 59 ½ and have had the account for at least five years, you can also withdraw any growth or earnings on your investments with no tax or penalty. If you expect to be in a higher tax bracket in retirement, this could lead to greater tax savings.

5. If you have more than one IRA, your total contributions can't go over the limit

For 2022, you can contribute up to $6,000 to a traditional IRA or Roth IRA if you're under 50—or up to $7,000 if you're 50 or older. You can contribute to multiple IRAs in the same year (for example, a Roth and a traditional IRA). But your combined contributions can't exceed the annual maximum. Your IRA contributions also can't exceed your earned income for the year.

6. Early IRA withdrawals can trigger a 10% penalty, but there are exceptions

In most cases, you'll owe a 10% penalty if you take contributions or earnings out of a traditional IRA before age 59 ½. With a Roth IRA, you must be 59 ½ and have had your account for at least five years to withdraw earnings, or you'll owe a penalty and income tax. But the IRS does allow exceptions, such as a first-time home purchase, educational expenses, unreimbursed medical costs, birth or adoption costs, health insurance if you're unemployed, and a few others.

7. You can leave an IRA to your heirs

Another benefit of an IRA is that you can name beneficiaries to inherit your savings. Heirs don't pay a penalty for taking the money out before age 59 ½. But if they inherit a traditional IRA, they'll owe income tax on withdrawals. If you leave your heirs a Roth IRA, they can withdraw the money tax-free. Other rules apply to inherited IRAs, so be sure to understand your options. 

8. Traditional IRAs require you to take taxable withdrawals starting at age 72—Roth IRAs don't

Owners of traditional IRAs must start taking required minimum distributions (RMDs) from their account at age 72. If you don't withdraw the minimum amount by the deadline, you'll be subject to a 50% tax penalty. On the other hand, Roth IRAs aren't subject to RMDs, so you can leave the money in your account for potential growth or withdraw it without increasing your taxable income. 

Keep in mind, traditional and Roth IRAs aren't the only types of IRAs

Depending on your situation, you may also want to consider a spousal IRA for spouses with no earned income (requires a joint tax return), a SEP or SIMPLE IRA for small business owners, or a rollover IRA if you want to move funds over from an old employer-sponsored retirement plan.

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Traditional IRA withdrawals are subject to ordinary income tax and prior to age 59½ may be subject to a 10% federal tax penalty.

If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and a 10% federal tax penalty.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for their own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

A rollover of retirement plan assets to an IRA is not your only option. Carefully consider all of your available options which may include but not be limited to keeping your assets in your former employer's plan; rolling over assets to a new employer's plan; or taking a cash distribution (taxes and possible withdrawal penalties may apply). Prior to a decision, be sure to understand the benefits and limitations of your available options and consider factors such as differences in investment related expenses, plan or account fees, available investment options, distribution options, legal and creditor protections, the availability of loan provisions, tax treatment, and other concerns specific to your individual circumstances.

The Schwab Center for Financial Research is a division of Charles Schwab & Company, Inc.