What is a contributory IRA? Is it any different from other types of IRAs? Should you consider opening one, or should you keep off such IRAs? You are about to find out about all that and more, so join me in today’s post where I will take you through the basics of Contributory IRAs. Read on till the end.
We are all headed to a point in our lives when we shall need to retire, and the sooner we consider starting to put aside some money for the future, the better. Saving for your retirement years through a retirement plan, however, is more complicated than allocating a fraction of your earnings to a savings account. You need to find out just which type of individual retirement account is suitable for you, based on your financial needs and goals in the future. There are also a bunch of rules that go with each type of IRA, which you need to be aware of before you sign the dotted line. In this post, we shall only look at what a contributory IRA is about, but I shall drop links to other types of IRAs that you should also highly consider looking at.
What is a Contributory IRA?
A Contributory Individual Retirement Account is another name for a type of IRA that is commonly referred to as a traditional IRA. This is one of the most common retirement accounts that you will find today, mainly because of the type of tax benefits that it offers to those who rely on it. These benefits are enjoyed both at the time one is depositing the funds into their account and throughout the IRA term. There are also some restrictions that apply for the contributions and withdrawals from this type of account.
This type of IRA allows individuals to make pre-tax contributions towards their investments so that they can grow tax-deferred. The IRS does not assess the account holders’ capital gains or their dividend income taxes until the time comes for them to start taking distributions. Contributory IRA holders are allowed to contribute 100% of their earned compensation up to a limited maximum dollar amount.
Contribution Limits that apply to a Contributory IRA
You are only allowed to contribute your earned income to your contributory account, such as the income earned from your wages. The maximum amount you can contribute to your account varies from year to year. As of 2022, the maximum contribution for those aged below 50 years is $6000, and $7000 for those aged above 50 years. If you have a non-working spouse, i.e. one who does not have an earned income, you can make contributions on their behalf, provided that your taxable income is above the amount you contribute to their account.
Note that under the SECURE Act, which was passed at the end of 2019, all age restrictions on contributory IRAs were lifted, to mean that as long as one has an earned income, they can contribute to this type of IRA.
Tax benefits of a contributory IRA
As already highlighted, one of the top benefits of a contributory IRA is that all the tax contributions are usually deferred until you are ready to start taking distributions, regardless of the total worth of your investments. All of the money you have put in the Contributory IRA remain untaxed until you decide to withdraw it, or it is time to take distributions.
This translates to an opportunity for your income to compound year on year, at a higher rate, since the investments remain untouched. When this happens over a couple of years, then you can rest assured that you are set to enjoy the benefits of compound interest despite not contributing hundreds of thousands of dollars to your account.
If you decide to make an early withdrawal, however, the IRS will hit you with a 10% early withdrawal penalty. An early withdrawal is one that happens when the Contributory IRA owner takes some funds from their account before they are 59 ½ years old.
Exceptions for early withdrawals
There are times when the IRS does not hit the account owners with the early withdrawal penalties, including the times in which they are withdrawing funds to:
- Buy or rebuild their first home for themselves or any qualified family member ( there is capped at $10,000 per lifetime).
- Meet their daily needs upon becoming disabled before the distribution occurs.
- Sustain their lifestyle as the beneficiaries of the account, upon the death of the IRA holder
- Meet the costs for unreimbursed medical expenses
- Pay for your medical insurance upon losing your job.
- Get funds if you are in the military and are expected to be on active duty for not less than 179 days.
- Meet the costs for higher education, or
- The expenses that come with bearing or adopting a child ( capped at $5000 in the year of birth or adoption).
It is, as such, quite important for an individual to consult with their attorney or with the IRS, to confirm that the situation that is making them make an early withdrawal qualifies for a waiver of the penalty.
Required Minimum Distributions
Once you turn 72, the IRS expects that you will start taking the required minimum distributions from your Contributory IRA. The first RMD should be taken by April 1 of the year after you turn 72, and all the subsequent distributions must be taken before Dec 31 every year. The penalty for not taking the required minimum distributions is usually 50% of all the funds that you were required to withdraw. It is, therefore, not a good idea to ignore the RMDs, since they can eat into your accumulated gains over the IRA term.
Frequently Asked Questions on “ Contributory IRA?”
1. I think I am past the age required to open and contribute to a Contributory IRA. Should I still try to open an account?
Yes. The SECURE Act of 2019 eliminated the age limit at which one can contribute to this type of IRA. Anyone aged 70 ½ was not allowed to open a Contributory IRA, prior to 1st January 2020.
The SECURE Act now allows for anyone who has an earned income to make their contributions to their Contributory IRA, regardless of their age.
2. How much money can I contribute to my Contributory IRA?
The IRS allows you to contribute any amount up to the lesser of 100% of your earned income, or up to $6000, for those aged below 50. Those aged over 50 are allowed to contribute an extra $1000 ( this amount is referred to as the catch-up contribution). The catch-up contribution provision enables those nearing their retirement years to save a significant amount of money so that they can maximize the benefits of their tax-advantaged accounts.
3. Can I roll over the funds in my 401(k) to my Contributory IRA?
Generally, yes. You may have to contact an IRA company so that their rollover specialists can guide you through the entire process since it can get a bit complicated. Also, there are potential landmines, in the form of tax penalties, for failing to stick to the set rollover guidelines.
4. Is it possible to roll over my Contributory IRA to a Gold IRA?
Yes. If you are looking for ways to diversify your portfolio by adding physical gold to it, then opening a Gold IRA and rolling over the funds in your Contributory IRA to it is a viable idea. A gold IRA is in itself a self-directed IRA, hence allowing you to add a wide variety of non-traditional assets ( e.g. precious metals, real estate, cryptos, and start-ups) to your account. You can do this while still accessing the underlying tax benefits of an IRA.
Also read about the following recommended gold, silver, and cryptocurrency investment posts:
That will be all for this post on what a Contributory IRA is about. I hope you found this post informative, and that it helped you understand much of what there is to know about this type of IRA. You can also learn a lot more about other types of IRAs by clicking on the links within the post, or by shooting any other question that you may have in mind.
I wish you well,
Eric. Investor and Team Member at Gold Retired!