19.3 Individual Retirement Accounts

Individual Retirement Accounts (IRAs)

IRAs provide individuals with tax-advantaged retirement savings outside of employer-sponsored plans. Understanding the different types and their rules is essential for the exam.

Types of IRAs

Traditional IRA

Contribution Limits (2025)

Deductibility Rules

Traditional IRA contributions may be fully deductible, partially deductible, or non-deductible:

If Covered by Employer Plan:

If NOT Covered by Employer Plan:

Key Point: Even if you can't deduct contributions, you can still make non-deductible contributions and benefit from tax-deferred growth.

Distribution Rules

Roth IRA

Contribution Eligibility (2025)

Contributions phase out based on income:

Contribution Limits (2025)

Important: The $7,000 limit is combined across all IRAs (Traditional + Roth). You cannot contribute $7,000 to each.

Qualified Distributions (Tax-Free)

A Roth IRA distribution is qualified (completely tax-free) if:

1. 5-year holding period met (from first contribution to any Roth IRA), AND
2. One of these triggering events:
   • Age 59½ or older
   • Death
   • Disability
   • First-time home purchase ($10,000 lifetime limit)

Ordering Rules for Non-Qualified Distributions

When taking non-qualified distributions, funds come out in this order:

1. Regular contributions (tax-free, penalty-free)
2. Conversion contributions (tax-free, may have 5-year penalty)
3. Earnings (taxable and subject to 10% penalty if non-qualified)

No RMDs During Lifetime

Unlike Traditional IRAs, Roth IRAs have no Required Minimum Distributions during the owner's lifetime. This makes Roths excellent for:

• Estate planning
• Those who don't need the money in retirement
• Leaving tax-free inheritance to beneficiaries

Backdoor Roth IRA

High earners who exceed Roth contribution limits can use the backdoor Roth strategy:

1. Contribute to a non-deductible Traditional IRA
2. Convert the Traditional IRA to a Roth IRA
3. Pay tax only on any earnings (minimal if converted quickly)

Pro-Rata Rule Warning

If you have existing Traditional IRA balances, the pro-rata rule applies:

• Conversion is proportionally taxable based on pre-tax/after-tax ratio
• All Traditional IRAs are aggregated for this calculation
• Can make backdoor Roth less attractive

Roth Conversions

You can convert Traditional IRA funds to Roth IRA:

10% Early Withdrawal Penalty Exceptions

Both Traditional and Roth IRAs (for earnings) allow penalty-free withdrawals for:

Spousal IRA

A spousal IRA allows a working spouse to contribute to an IRA for a non-working spouse:

IRA Rollovers and Transfers

One-Rollover-Per-Year Rule

• Only ONE indirect (60-day) rollover allowed per 12-month period
• Applies across all IRAs (not per-account)
• Direct trustee-to-trustee transfers are unlimited
• Roth conversions do not count toward this limit

Required Minimum Distributions (RMDs)

RMD Rules for Traditional IRAs (Post-SECURE 2.0)

RMD Calculation

RMD = Account Balance (Dec. 31 prior year) ÷ Life Expectancy Factor

RMD Penalty

Key Takeaways

• Traditional and Roth IRAs offer tax-advantaged savings with a combined $7,000 limit plus $1,000 catch-up (2025).
• Traditional IRA deductibility depends on employer coverage and MAGI phase-outs; RMDs begin at age 73.
• Roth IRA eligibility is income-limited and qualified distributions require a 5-year rule plus a triggering event.
• Roth ordering rules return contributions first, then conversions, then earnings; no RMDs for the owner.
• Backdoor Roth contributions must follow the pro-rata rule; conversions are taxable but penalty-free.
• IRAs allow penalty exceptions for specific events such as disability, education, or first-time home purchase.
• Spousal IRAs and rollover rules (direct transfers, 60-day limit, one-per-year) are common exam topics.