Definition:
An IRA contribution is a deposit made into an Individual Retirement Account (IRA). These contributions can help individuals save money for retirement and receive tax benefits.
How IRA Contributions Work
An IRA contribution is a deposit you make into an IRA account. There are several different types of IRAs, such as traditional IRAs, Roth IRAs, and Simplified Employee Pension IRAs (SEP-IRAs).
Typically, an IRA contribution begins with opening an IRA account at a qualified financial institution such as a broker or bank. You may have the option to manage your IRA yourself or allow the financial institution to manage your IRA for you. From there, you can make cash contributions to your IRA via bank transfers, checks, or cash, in most cases. You can make contributions in a lump sum each year or spread them out over periods.
For any given tax year, you can make IRA contributions at any time up until the tax return filing deadline for that year, so you have more time than the calendar year to make contributions. For example, IRA contributions for the 2022 year can generally be made until around the tax return filing deadline in 2023.
To make a traditional contribution or a Roth IRA contribution for a specific year, you must have taxable income for that year. You can then contribute up to or even the amount of taxable income you earned or the annual contribution limits; for 2022, this is $6,000 if you are under age 50, and $7,000 if you are age 50 or older. For 2023, those figures are $6,500 and $7,500, respectively.
The taxable income rule may help minors contribute to an IRA, such as if a teenager earns a little money as part-time income. A parent or another family member may open a custodial account that the child can access upon reaching adulthood.
Note: Sometimes individuals transfer assets from one IRA account to another. In this case, it may involve non-cash transfers. Transfers do not count toward contribution limits.
Example of IRA Contributions: For example, let’s say you set up an IRA and decided to make automatic monthly contributions of $400 this year. In theory, the value of your contributions will grow as the investments held in your IRA increase.
Tax Benefits of Contributions to Traditional IRAs
Generally, you can deduct traditional IRA contributions in full if you do not have an employer-sponsored retirement plan.
If you have access to a retirement plan at work, here are the deduction rules for general contributions for the 2022 tax year, based on modified adjusted gross income (MAGI):
- Married filing jointly or head of household: $78,000 or more – None
- Married filing jointly or head of household: More than $68,000 but less than $78,000 – Partial
- Married filing jointly or head of household: $68,000 or less – Full up to your contribution limit
- Married filing jointly or qualifying widow(er): $129,000 or more – None
- Married filing jointly or qualifying widow(er): More than $109,000 but less than $129,000 – Partial
- Married filing jointly or qualifying widow(er): $109,000 or less – Full up to your contribution limit
If you are married and file jointly and do not have access to a retirement plan at work, but your spouse does, you can still get the full deduction if your modified adjusted gross income (MAGI) is up to $204,000 for the 2022 tax year. You will get a partial deduction if your income is more than $204,000 but less than $214,000, and you will not receive any deduction if your modified adjusted gross income (MAGI) is $214,000 or more.
Note:
Roth IRA contributions cannot be deducted from taxes. Instead, the U.S. tax office allows you to take qualified distributions (withdrawals) tax-free, while qualified distributions from a traditional IRA are subject to taxes. Income limits also apply to Roth IRA eligibility, even if you do not have access to an employer-sponsored retirement plan. Additionally, IRA limits count the traditional contributions and Roth IRA contributions combined, rather than allowing you to deposit $6,000 into each account in the 2022 tax year.
Other types of IRAs, such as SEP IRAs, are considered employer-sponsored retirement plans. These plans have much higher contribution limits and may affect your ability to deduct contributions to a traditional IRA.
What IRA Contributions Mean for Individuals
Understanding what IRA contributions are and how to make IRA contributions can help you save money for retirement. Personal factors such as your income and access to an employer-sponsored retirement plan may impact the type of IRA you contribute to, if any. For those who contribute, IRAs can help you save through tax deductions (traditional IRA) or tax-free qualified withdrawals (Roth IRA).
Frequently Asked Questions (FAQs)
What is considered an IRA contribution?
An IRA contribution includes the money you deposit into your IRA account. IRAs have contribution limits, and these limits tend to increase over time.
Do IRAs earn interest?
IRAs typically do not earn a rate of interest. Instead, they generate gains and losses based on the investments held within them.
Source: https://www.thebalancemoney.com/what-is-an-ira-contribution-5225710
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