Any employed person is eligible to contribute to a Traditional IRA, but not all such contributions are deductible from income taxes. Deductibility is a factor of income as well as coverage under an employer retirement plan. Such deductions are subject to the following eligibility rules:

  • If a person is not currently covered by a retirement plan at work, IRA contributions are deductible in full.
     
  • If a person is currently covered by a retirement plan at work, IRA contributions are deductible only if income is less than the limits shown below:
YEAR Single Return Joint Return
2004 $45,000-$55,000 $65,000-$75,000
2005 $50,000-$60,000 $70,000-$80,000
2006 $50,000-$60,000 $75,000-$85,000
2007 $50,000-$60,000 $80,000-$100,000
  • If income falls between the limits shown above, the contribution will be partially deductible - the deduction is "phased out" in proportion to the amount by which the income exceeds the lower limit in the range.
     
  • For a married couple, if only one spouse is covered by a pension plan, a different phase-out rule applies:
    • If combined income is $150,000 or less, the contribution for the non-covered spouse is fully deductible.
       
    • If combined income is between $150,000 and $160,000, a proportional phase-out applies.
       
    • If combined income is $160,000 or higher, no deduction applies.
       
    • These rules apply only to the non-covered spouse; contributions by the covered spouse are not deductible.

Exam Tips and Tricks
On the exam, you will not be tested on the actual dollar values for the phase-out. However, you will need to know that clients with high incomes are subject to different phase-out rules.

The following information applies to Traditional IRAs only:

  • Earnings are tax-deferred until withdrawn.
     
  • If deductible contributions are made, 100% of withdrawals are subject to taxation at ordinary income rates.
     
  • If non-deductible contributions are made, a portion of each withdrawal is not taxable.
     
  • Withdrawals made prior to age 59 ½ are subject to a 10% penalty, unless one of the following exceptions applies:
    • Death
    • Disability
    • Eligible educational expenses
    • First-time home-buying expenses (up to $10,000)
    • Distributions made over the life expectancy of the IRA owner
       
  • Contributions may not be made after the IRA owner turns age 70 ½ - even if he or she is still employed.
     
  • Distributions made over the life expectancy of the IRA owner must begin no later than April 1 of the year following the year in which the owner turns age 70 ½.
     
  • If a person fails to withdraw any amount that should have been distributed under these mandatory minimum requirements, a 50% tax penalty applies to the amount not distributed.

For more on how a traditional IRA works, how to set one up and even how to withdraw from it, review the tutorial Traditional IRAs.



Roth IRAs

Related Articles
  1. Financial Advisor

    IRAs: Top Things You Need to Know About Them

    By understanding the major rules for both traditional and Roth IRAs, you'll be prepared to enjoy the benefits of these investment opportunities.
  2. Retirement

    IRA Contribution Limits in 2016

    Find out about the 2016 limits for contributions and income thresholds for individual retirement accounts, including traditional IRAs and Roth IRAs.
  3. Retirement

    How Much It Takes to Max Out Your IRA

    IRAs have certain tax advantages that allow your nest egg to grow at a faster rate. But there are annual limits on how much you can contribute.
  4. Retirement

    How Traditional IRAs Work

    A traditional IRA is a tax-advantaged retirement account that includes stocks, bonds, mutual funds and other investments.
  5. Retirement

    Roth IRA Contribution Limits in 2016

    Discover the benefits of Roth IRA accounts and how much you can contribute for your retirement. Learn which IRA plan is best for you.
  6. Financial Advisor

    7 Top IRA Strategies for Your Clients

    With IRA season in full swing, advisors should consider these seven strategies for clients.
  7. Retirement

    Top 10 Mistakes To Avoid On Your IRA

    IRA rules are complicated. It's easy to make mistakes – and they can cost you big time.
  8. ETFs & Mutual Funds

    IRAs and Roth IRAs

    What IRAs are: Tax-advantaged savings accounts for individuals. Pros: Tax benefits; investments grow tax-deferred and contributions may be deductible; numerous investment choices with range of ...
  9. Retirement

    Maxed Out Your 401k? Here's What to Do Next

    Maxed out your 401(k)? Don't stop there. Here are some options to keep saving toward retirement.
  10. Retirement

    Roth IRA Contribution Rules: The Basics

    What you need to know about Roth IRA contributions – from eligibility to dollar limits, deadlines to tax breaks.
Trading Center