3 IRA Rules You Should Know by Heart

Did you know that you may be able to use your IRA funds early under certain circumstances? Or that you can't contribute to an IRA unless you earn income from a job or business? These are just a couple of examples of IRA rules that all retirement investors should know.

With that in mind, here are the rules regarding IRA contribution limits, early withdrawal exemptions, and income limitations.

How much you can contribute to an IRA

The simple rule is that you can contribute up to $5,500 to your IRA for 2017, with an additional $1,000 catch-up contribution allowed if you're 50 or older, for a total maximum of $6,500. However, there are a few things you should know about this limit.

First, this limit is per person, not per account. In other words, if you have three different IRAs, your total contributions for the year can't exceed the limit.

Second, the contribution limit is for the tax year, but you can make your contributions until the April tax deadline of the following calendar year. In other words, you can make your 2017 IRA contributions until 2018's tax deadline, which falls on April 17.

Finally, you need to earn income in order to contribute to an IRA. This means that you need income from an employer, or from a business you're actively involved in. If your income comes from passive sources, such as dividends and investment gains, you can't use it for the purposes of qualifying for an IRA. In fact, the annual limit is $5,500 or your total earned income, whichever is lower. There are also upper income limits that apply in certain circumstances, which I'll discuss later.

IRA early withdrawal exceptions

Generally speaking, you can't withdraw money from an IRA until you turn 59 1/2 years old without having to pay a 10% early withdrawal penalty. However, there are a few notable exceptions to be aware of.

There's a one-time exemption that allows you to withdraw up to $10,000 for a first-time home purchase, either for yourself or a relative. You can also withdraw any amount of money penalty-free to cover qualified higher education expenses. There's also an exception to cover medical expenses in excess of 10% of your adjusted gross income, or to cover health insurance premiums while you're unemployed.

Roth IRAs have an extra exception. Since Roth contributions are made on an after-tax basis, meaning that you're not getting an immediate tax advantage for contributing, you are free to withdraw them any time. You can only withdraw your original contributions, not any investment profits, but this makes a Roth IRA a smart choice for people who don't necessarily want their money tied up until retirement.

IRA income limitations

To be fair, you don't need to memorize the IRA income limitations -- just be aware that they exist, and whether or not your income puts you at risk of not being allowed to contribute.

Traditional IRA contributions are not limited by income. Anyone can contribute to a traditional IRA and allow their investments to grow and compound tax-deferred, regardless of income. However, the traditional IRA tax deduction is limited by income for certain people, and this is the main incentive to choose a traditional IRA over a Roth IRA.

If you (and your spouse, if applicable) are not eligible to participate in an employer's retirement plan, there is no income limit to take the traditional IRA deduction. If you (or your spouse) are covered through an employer-sponsored retirement plan, these are the 2017 income limits for the traditional IRA deduction (all income figures refer to adjusted gross income, or AGI):

Here's how this works: If your AGI is below the lower limit for your filing status and employer-sponsored retirement plan situation, you qualify for a full traditional IRA deduction. If your AGI is between the two numbers, you can take a partial deduction. And finally, if your AGI exceeds the upper limit, you are not eligible for a traditional IRA deduction.

For a Roth IRA, there are income limits for contribution eligibility that apply to everyone, regardless of your employer-sponsored retirement plan eligibility. They work the same way as I discussed for the traditional IRA limits, in terms of full eligibility, partial eligibility, and no eligibility. For the 2017 tax year, these are:

As a final thought, these are the limits to contribute directly to a Roth IRA. If you exceed the income limits, there is a backdoor method of contributing to a Roth IRA that consists of contributing to a traditional IRA (remember, you can do this no matter how much you make) and then converting the account to a Roth IRA.

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