Traditional IRA Rules for Tax Year 2014

Don't Forget to Fund a Traditional IRA Before the April 15th, 2015 Deadline!

Traditional IRA Rules
The Traditional IRA rules allow you to wait until as late as April of 2015 to fully fund your 2014 tax year IRA contribution limits. Jupiterimages / Stockbyte / Getty Images

There is still time to fund a Traditional IRA for tax year 2014 before the deadline hits in April of 2015!  The Traditional IRA, which combines tax-write offs for most investors who make a contribution, tax-deferral for almost all capital gains, dividends, interest, rents, and other profits earned by assets held within the account, and even heightened protection from creditors in bankruptcy court, is one of the easiest, best ways to build wealth for your family.

 If you're going to take advantage of the lucrative perks it offers, you have to do so before it's too late because Congress only permits a use-it-or-lose-it annual contribution limit. Once it's gone, it's gone.  You can never make it up or go back in time and fund the amounts you've missed.

A Basic Overview of How a Traditional IRA Works

In case you've forgotten or have had no reason to research how a Traditional IRA works, for most people, it goes something like this:

  • You open a Traditional IRA with a stock brokermutual fund, bank, or other financial institution, each of which will have its own product offerings.
  • You contribute money to this Traditional IRA, receiving a tax deduction for the amount you deposit.  Because the tax deduction is so attractive, Congress places strict limits on the amount you can add to a Traditional IRA in any given tax year.
  • Once the money is in your Traditional IRA, you use it to invest in stocksinvest in bondsinvest in mutual fundsbuy real estate, or a host of other assets. If you open a Traditional IRA at a local bank, they might only allow you to purchase FDIC insured certificates of deposit.  If you open a Traditional IRA with a discount broker such as Charles Schwab, they'll allow you to do anything from purchasing shares blue chip stocks to index funds.
  • During the years, perhaps even decades, you keep assets in the Traditional IRA, the profits generated by those investments are tax-free.  If you hold $1,000,000 worth of oil and bank stocks that pay you $40,000 a year in cash dividends, under almost all circumstances, you won't have to pay a penny in taxes to Federal, local, or state level.  (Some foreign stocks apply taxes if they don't have a favorable tax treaty with the United States so be careful when acquiring international assets in a Traditional IRA unless you know what you are doing.)
  • Any time after 59.5 years old, you can begin making withdrawals from the Traditional IRA without paying a 10% penalty that applies prior to this age unless you meet one of the exemptions.  When you take the money out of the account, it will be reported on your taxes as regular income.  You'll pay taxes on these withdrawals as they serve as a de facto paycheck upon which you live for the rest of your life.
  • Once you are 70.5 years old, the IRS will begin making you take something known as the mandatory minimum withdrawal to stop you from benefiting from the Traditional IRA tax shelter for too long.

How Much Money Can a Person Contribute to a Traditional IRA in Tax Year 2014?

The Traditional IRA contribution limit for tax year 2014 depends on your age.  Congress allows older Americans to put aside more money in what is known as a "make-up" contribution so they can supercharge their retirement savings in the years before they hang up their proverbial time card.

  • Those 49 years or younger can contribute up to a maximum of $5,500 to their Traditional IRA
  • Those 50 years or older can contribute up to a maximum of $6,500 to their Traditional IRA

Married couples can each have a Traditional IRA to maximize the amount they can save within the tax shelter.

 For example, if a 52 year old man were married to a 48 year old woman, they could put aside a combined total of $12,000, with $6,500 going into his IRA and $5,500 going into her IRA.  This is true even if one of the spouses doesn't work.  Ordinarily, a person must have what is known as "earned income" to fund one of these accounts but Congress wrote the rules to allow a stay-at-home husband or wife to save using the combined household funds so as not to punish homemakers.

Traditional IRA Income Limits for Tax-Write Off Eligibility in Tax Year 2014

In many cases, money you contribute to a Traditional IRA should be tax deductible on your family's return, allowing you to lower your bill to Uncle Sam.

 This was done to give individual citizens an incentive to invest for their future.  The income limits for enjoying this deductibility depends on whether or not you are covered by a retirement plan at work.

Note that the IRS determines "income" for the purposes of Traditional IRA eligibility using a formula known as "Modified Adjusted Gross Income".  This is different from the normal adjusted gross income you hear about on your tax return.  It involves removing passive losses or passive income, rental loses on real estate investments, half of the self-employment tax, income generated from IRA withdrawals or Social Security benefits, write-offs from qualified tuition expenses, student loan interest, and more.  If you think you are near one of the income limits, don't just take it on faith, talk to an accountant because it's entirely possible you won't be once the formula has been applied to your income statement.

For investors who are not covered by a retirement plan at their job, such as a 401(k) or 403(b), the Traditional IRA tax deduction rules are as follows:

  • Single, Head of Household, or Qualifying Widow(er) = No limit on tax deductibility based on modified adjusted gross income.  Any modified AGI is fully deductible up to the amount of your contribution limit.
  • Married Filing Jointly or Separately with a Spouse Who Is Also Not Covered by a Retirement Plan at Work = No limit on tax deductibility based on modified adjusted gross income.  Any modified AGI is fully deductible up to your contribution limit.
  • Married Filing Jointly with a Spouse Who Is Covered By a Retirement Plan at Work = A modified adjusted gross income of $181,000 or less is entitled to full deductibility up to the amount of your contribution limit.  Between $181,000 and $191,000, the tax deduction you can take is phased out with lower and lower amounts until reaching $191,000, at which point, you cannot take any tax deduction for your Traditional IRA contribution.

For investors who are covered by a retirement plan at their job, the Traditional IRA tax deduction rules are as follows:

  • Single or Head of Household = A modified adjusted gross income of $60,000 or less entitles you to a full tax deduction on the entire amount of your Traditional IRA contribution up to the contribution limit.  If you earn more than $60,000 but less than $70,000, you can claim a partial deduction on your taxes.  If you earn $70,000 or more, you can't take any deduction for your Traditional IRA contribution.
  • Married Filing Jointly or Qualifying Widow(er) = A modified adjusted gross income of $96,000 or less entitles you to a full tax deduction on the entire amount of your Traditional IRA contribution up to the contribution limit.  If you earn more than $96,000 but less than $116,000, you can claim a partial tax deduction.  If you earn $116,000 or more, you can't claim any tax deduction for your Traditional IRA contribution.
  • Married Filing Separately = A modified adjusted gross income of less than $10,000 entitles you to a partial tax deduction on your Traditional IRA contribution.  An income of $10,000 or more means you can't take any deduction.

In both cases, if you file your taxes separately and you did not live with your spouse at any time in the past year, the IRS will allow you to use the "single" rules to determine your Traditional IRA tax deduction eligibility.

If You Qualify, Consider a Roth IRA Instead of a Traditional IRA

On a final note, you might want to consider a Roth IRA instead of a Traditional IRA.  In practically every conceivable case, the Roth IRA is a better choice but not everyone is eligible (there are ways around it but that is another article for another day).  While a Roth IRA will cause you to pay a little more taxes up front relative to a Traditional IRA, in the long-run, you should pay far less to the Federal, state, and local governments as a result of the rules that govern the retirement tax shelter.  That means more money for you, your family, your alma matter, your favorite charity, or whomever or whatever else you want to support with your pocketbook.

If you decide to go with a Roth IRA, check out the Roth IRA Rules for tax year 2014.  As with the Traditional IRA, you have until the April, 2015 tax deadline to fund the account.