A common question I receive from Money Girl podcast listeners is about how to handle money in an IRA or Individual Retirement Arrangement.
Judy wants to know: Is it possible to loan money from my traditional IRA to my sister so she can buy a home?
Keep reading and I’ll give you the answer to this question plus 10 IRA rules that everyone should know.
Can You Take a Loan from an IRA?
It’s not possible to take a loan from any type of IRA-based retirement plan, such as a traditional IRA, Roth IRA, or SEP-IRA; however, you can take a withdrawal. If you’re younger than age 59½, taking a withdrawal from a traditional IRA does trigger income tax plus an additional 10% penalty.
If you withdraw money from a Roth IRA, the rules are different. Roth contributions can be withdrawn with no tax consequences (because they are made on an after-tax basis), but earnings are still subject to income tax plus the 10% penalty.
So Judy can take a hefty tax hit and make an early withdrawal from her traditional IRA for her sister, but I don’t recommend it. You can’t just pay a withdrawal back to an IRA. You’re subject to annual contribution limits.
10 IRA Rules Everyone Should Know
Here are 10 more important IRA rules that you should know:
Rule #1: You Don’t Have to Contribute Every Year
You choose whether you want to contribute to an IRA each year or not. If you open up a traditional or Roth IRA, but don’t make any additional contributions, your account stays open indefinitely.
Rule #2: An IRA Can Only Be Owned by an Individual
All retirement accounts must be owned by individuals, even if you’re married. There’s no such thing as a joint retirement account. You’re not allowed to mix funds either, by rolling over one person’s retirement money into another person’s retirement account.
Rule #3: You Need Earned Income to Qualify
If you have taxable compensation during the year—such as salaries, wages, tips, bonuses, commissions, and self-employment income—you’re eligible to contribute to a traditional or a Roth IRA. You can contribute an amount equal to your taxable compensation up to $5,000 or up to $6,000 if you’re age 50 or older.
Rule #4: Minors Qualify Too
Anyone with earned income can contribute to an IRA, no matter your age. So children can start saving for retirement as soon as they get their first part-time job. They can contribute as much as they earn, up to the maximum limit of $5,000 for 2011.
Rule #5: Spouses Without Earned Income May Qualify
If you’re married and file a joint tax return and just one of you has income, both of you can have an IRA. That helps an unemployed or stay-at-home spouse save for retirement.
Rule #6: You Can’t Make IRA Contributions for Someone Else
Each owner of a retirement account must qualify to open up and contribute to an IRA. So a parent can’t fund a retirement account on behalf of a child, for instance, if the child doesn’t have earned income. However, if a child does have earned income, the money to fund an IRA could come from a parent.
Rule #7: Roth IRA Qualification Depends on Income
The amount you can contribute to a Roth IRA is reduced or eliminated when your income reaches certain limits. For 2011, single taxpayers can’t have modified adjusted gross income that’s $120,000 or more. The Roth cutoff for married people who file a joint tax return is $177,000.
Rule #8: You Can Keep an Inactive Roth IRA
If you contributed to a Roth IRA in the past but now make too much money to be eligible, congratulations! But don’t let that stop you from saving for retirement—you can open up and contribute money to a traditional IRA instead, or contribute to your employer sponsored retirement plan. If your income falls below the Roth cutoff in the future, you can start making contributions again to the same Roth IRA.
Rule #9: You Can Have Multiple IRAs
You can open up and contribute to as many traditional and Roth IRAs as you like. However, your total contributions to all of them can’t exceed your annual allowable limit (which is $5,000 if you’re under 50 for 2011). You can make any combination of contributions in the same year, such as $1,000 to a Roth IRA and $4,000 to a traditional IRA.
Rule #10: You Can Have an IRA and a Workplace Retirement Account
You can contribute to a retirement plan at work—like a 401(k), 403(b), or 457—and still max out contributions to an IRA in the same year. However, if you or your spouse has a workplace retirement plan, the tax deduction for your traditional IRA contributions may be reduced or eliminated, depending on your income.
Chapter 7 of my book, Money Girl’s Smart Moves to Grow Rich, tells you everything you need to know about the different types of retirement accounts, no matter if you’re employed, self-employed, or unemployed. You can grab 2 free chapters now at SmartMovesToGrowRich.com.