10.3 Individual Retirement Accounts

What Is an IRA?

An Individual Retirement Account (IRA) is a personal, tax-advantaged account an individual opens outside an employer plan. IRAs are governed by the Internal Revenue Code, not ERISA, so they lack ERISA creditor protection (though most states and federal bankruptcy law shield them up to limits). To contribute, you need earned income (wages or self-employment income) at least equal to the contribution — investment income and Social Security do not count. A non-working spouse may use a spousal IRA based on the working spouse's compensation on a joint return.

2026 Contribution Limits (IRS Notice 2025-67)

The limit is an aggregate across all Traditional and Roth IRAs — you cannot put $7,500 in each. Contributions for a tax year may be made until the April filing deadline of the following year (about April 15, 2027 for tax year 2026). Excess contributions left uncorrected face a 6% excise tax each year.

Traditional IRAs

Contributions to a Traditional IRA may be tax-deductible, growth is tax-deferred, and every dollar withdrawn is taxed as ordinary income (never capital gains). Deductibility depends on whether you (or a spouse) are an active participant in an employer plan and on your modified adjusted gross income (MAGI).

2026 Traditional IRA Deduction Phase-Out (active participant)

If neither spouse is covered by a workplace plan, the contribution is fully deductible regardless of income. A non-deductible contribution is still allowed — it simply creates after-tax basis that is not taxed again at distribution.

Traditional IRA distribution rules

• Before age 59 1/2: ordinary income tax plus a 10% penalty (with exceptions).
• Required Minimum Distributions (RMDs): must begin by April 1 of the year after turning 73 (SECURE 2.0; rising to 75 in 2033).
• Missed RMD penalty: 25% of the shortfall, reduced to 10% if corrected within the two-year window.

Roth IRAs

Roth IRA contributions are after-tax (never deductible), growth is tax-free, and qualified distributions are entirely tax-free. A distribution is qualified when the account has been open 5 years and the owner is 59 1/2, disabled, deceased, or making a first-time home purchase (up to a $10,000 lifetime cap). Roth IRAs have no RMDs during the owner's lifetime — a major planning advantage.

2026 Roth IRA MAGI phase-out (eligibility to contribute)

High earners above these limits often use a backdoor Roth: contribute to a non-deductible Traditional IRA and then convert it to a Roth.

Roth withdrawal ordering

Distributions come out in a fixed order, which the exam tests: (1) contributions first (always tax- and penalty-free), (2) converted amounts next (each conversion has its own 5-year penalty clock), and (3) earnings last (taxable and possibly penalized unless qualified).

Traditional vs. Roth at a Glance

Choose Traditional when you expect a lower tax bracket in retirement or need the deduction now; choose Roth when you expect higher future rates, want tax-free income, or want to skip RMDs.

Rollovers and Transfers

A direct (trustee-to-trustee) transfer moves money between custodians without the owner touching it: no withholding, no 60-day deadline, and unlimited frequency. An indirect (60-day) rollover pays the owner first and must be redeposited within 60 days; the IRS allows only one indirect rollover per 12 months per person across all IRAs. Distributions from employer plans carry 20% mandatory federal withholding, so to roll the full amount the owner must replace the withheld 20% from other funds or that portion becomes a taxable, possibly penalized, distribution.

Permitted IRA Investments and Prohibited Transactions

The Series 7 tests what an IRA may and may not hold. Permitted: stocks, bonds, mutual funds, ETFs, U.S.-minted gold and silver coins, certain CDs, and annuities (though buying a tax-deferred annuity inside an already tax-deferred IRA offers no extra tax benefit and is usually unsuitable). Prohibited: life insurance, collectibles (art, antiques, gems, most coins, alcoholic beverages), and short sales or naked options that create unlimited risk or margin. Covered call writing is generally acceptable.

IRAs are also subject to prohibited-transaction rules: the owner may not borrow from the IRA, use it as loan collateral, sell personal property to it, or engage in self-dealing. A violation can disqualify the entire account, making it fully taxable. Excess contributions, as noted, draw a 6% excise tax until withdrawn.

Spousal IRAs, Beneficiaries, and Inherited Accounts

A spousal IRA lets a working spouse fund an IRA for a non-earning spouse, effectively doubling household IRA savings to $15,000 (or $17,200 with catch-ups) in 2026 on a joint return. Naming a beneficiary keeps the IRA out of probate and controls how it passes. Under SECURE Act rules, most non-spouse beneficiaries must empty an inherited IRA within 10 years of the owner's death (the "10-year rule"), rather than stretching distributions over their own lifetime. A surviving spouse has more flexibility and may treat the inherited IRA as their own.

These beneficiary mechanics are common exam material because they determine the timing and taxation of distributions for the next generation.