An Individual Retirement Account (IRA) is a tax-friendly retirement savings plan. In a standard IRA, contributions are tax-deductible, but tax must be paid on all withdrawals. In a Roth IRA, designated Roth contributions are included in gross income. However, Roth IRA earnings are non-taxable, providing the conditions of the Roth account are met.
The contribution levels for both standard and Roth IRAs are the same. In both cases, the maximum amount which may be contributed to an IRA or combination of IRAs per year is the lower of earned income or contribution limit. All contributions except rollovers or transfers must be made with cash or cash equivalents.
For the 2011 tax year, the IRA contribution limit is $5,000. If you are 50 years of age or older at the end of the tax year, you can add an extra $1,000, for a total of $6,000. If you do not use the full amount of your IRA contribution limit in 2011, the difference does not carry over into 2012.
All contributions to your IRA do not have to be added into the account in one lump sum. Instead, you might choose to divide your contribution into smaller payments over the course of the year.
These contribution limits are over and above the contribution limits for a 401k. Employees may hold both an IRA and a 401k at the same time, and contribute the maximum amount to each.
However, your IRA contribution limit is for all your IRAs together, even if they are of different kinds. You cannot contribute the maximum amount to each IRA separately.
For standard IRAs, there is also a phaseout limit on contributions. If you are covered by a retirement plan at work and you are single, the 2011 phaseout applies between $56,000 and $66,000. If you are married, filing jointly, and are covered by a work retirement plan, the phaseout applies between $90,000 and $109,000. If you are not covered by a retirement plan at work and you are married, filing jointly, the phaseout applies between $169,000 and $179,000. The phaseout does not apply if you are single and not covered by a retirement plan at work.
IRA contributions can also be made on behalf of the spouse. Employees have no reporting obligation for designated Roth contributions made to a Roth IRA. A surviving spouse who also holds a Roth IRA can combine the two Roth IRAs into a single plan without any tax penalty. Thus, in estate planning, it is almost always a good idea to keep money in a Roth IRA.
Funds in an IRA must be kept in the plan for a minimum of 5 consecutive tax years. Qualified distributions can begin anytime after the employee is 59-1/2 years old, provided the 5 year seasoning period has passed. Although tax must be paid on distributions from standard IRAs, all qualified distributions from Roth IRAs are completely tax-free.