A traditional IRA is any IRA that is not a Roth or SIMPLE IRA
Who Can Set Up a Traditional IRA?
You can set up and make contributions to a traditional IRA if:
- You (or, if you file a joint return, your spouse) received taxable compensation during the year, and
- You were not age 70½ by the end of the year.
You can have a traditional IRA whether or not you are covered by any other retirement plan. However, you may not be able to deduct all of your contributions if you or your spouse is covered by an employer retirement plan. See How Much Can You Deduct , later.
What Is Compensation?
Generally, compensation is what you earn from working. Compensation includes all of the items discussed next (even if you have more than one type).
Wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services are compensation. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.
An amount you receive that is a percentage of profits or sales price is compensation.
If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the total of:
- The deduction for contributions made on your behalf to retirement plans, and
- The deduction allowed for one-half of your self-employment taxes.
Compensation includes earnings from self-employment even if they are not subject to self-employment tax because of your religious beliefs.
If you have a net loss from self-employment, do not subtract the loss from your salaries or wages when figuring your total compensation.
For IRA purposes, compensation includes any taxable alimony and separate maintenance payments you receive under a decree of divorce or separate maintenance.
For IRA purposes, compensation includes military differential pay you receive. Military differential payments are those payments made by some employers to employees who have been called to active duty in the uniformed services for a period of more than 30 days. Beginning in 2009, these payments will be reported in box 1 (Wages, tips, other compensation) of Form W-2.
If you were a member of the U.S. Armed Forces, compensation includes any nontaxable combat pay you received. This amount should be reported in box 12 of your 2009 Form W-2 with code Q. If you received nontaxable combat pay in 2004 or 2005, and the treatment of the combat pay as compensation means that you could contribute more for those years than you already have, you could have made additional contributions to an IRA for 2004 or 2005 by May 28, 2009. The contributions are treated as having been made on the last day of the year you designate. If you have already filed your return for a year for which you make a contribution, you must file Form 1040X, Amended U.S. Individual Income Tax Return, by the latest of:
- 3 years from the date you filed your original return for the year for which you made the contribution,
- 2 years from the date you paid the tax due for the year for which you made the contribution, or
- 1 year from the date on which you made the contribution.
|Includes||Does not include|
|wages, salaries, etc.||earnings and profits from property.|
|commissions||interest and dividend income|
|self-employment income||pension or annuity income|
|alimony and separate maintenance||deferred compensation|
|military differential pay||income from certain partnerships|
|nontaxable combat pay||any amounts you exclude from income|
What Is Not Compensation?
Compensation does not include any of the following items.
- Earnings and profits from property, such as rental income, interest income, and dividend income.
- Pension or annuity income.
- Deferred compensation received (compensation payments postponed from a past year).
- Income from a partnership for which you do not provide services that are a material income-producing factor.
- Any amounts (other than combat pay) you exclude from income, such as foreign earned income and housing costs.
You can set up different kinds of IRAs with a variety of organizations. You can set up an IRA at a bank or other financial institution or with a mutual fund or life insurance company. You can also set up an IRA through your stockbroker. Any IRA must meet Internal Revenue Code requirements. The requirements for the various arrangements are discussed below.
An individual retirement account is a trust or custodial account set up in the United States for the exclusive benefit of you or your beneficiaries. The account is created by a written document. The document must show that the account meets all of the following requirements.
- The trustee or custodian must be a bank, a federally insured credit union, a savings and loan association, or an entity approved by the IRS to act as trustee or custodian.
- The trustee or custodian generally cannot accept contributions of more than the deductible amount for the year. However, rollover contributions and employer contributions to a simplified employee pension (SEP) can be more than this amount.
- Contributions, except for rollover contributions, must be in cash. See Rollovers.
- You must have a nonforfeitable right to the amount at all times.
- Money in your account cannot be used to buy a life insurance policy.
- Assets in your account cannot be combined with other property, except in a common trust fund or common investment fund.
- You must start receiving distributions by April 1 of the year following the year in which you reach age 70½.
When Must You Withdraw Assets? (Required Minimum Distributions)
You cannot keep funds in a traditional IRA indefinitely. Eventually they must be distributed. If there are no distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required. The requirements for distributing IRA funds differ, depending on whether you are the IRA owner or the beneficiary of a decedent’s IRA.
If you are the owner of a traditional IRA, you must generally start receiving distributions from your IRA by April 1 of the year following the year in which you reach age 70½. April 1 of the year following the year in which you reach age 70½ is referred to as the required beginning date.
Figure your required minimum distribution for each year by dividing the IRA account balance (defined next) as of the close of business on December 31 of the preceding year by the applicable distribution period or life expectancy.