2024 IRA Contributions for Beginners

There are only three types of annual contributions to individual retirement accounts (“IRAs”). They are:

• Traditional, nondeductible contributions
• Traditional, deductible contributions
• Roth contributions

This post discusses when a taxpayer can make one or more of these types of annual contributions.

Let’s dispense with what we are not talking about. This post has nothing to do with annual contributions to employer retirement plans (401(k)s and the like) and self-employed retirement plans. We’re only talking about IRAs. The Individual in “IRA” is the key – anyone can set up their own IRA. IRAs are not pegged to any particular job or self-employment.

The above list is the exhaustive list of the possible types of annual contributions you can make to an IRA. But there is plenty of confusion about when you are eligible to make each of the three types of annual contributions.

Why Contribute to an IRA?

Before we dive into annual contributions to IRAs, let’s discuss why you would consider contributing to an IRA. The main reason is to build up tax-deferred wealth (traditional IRAs) and/or tax-free wealth (Roth IRAs) for your future, however you define it: financial independence, retirement, etc. A second potential benefit is the ability to deduct some annual contributions to traditional IRAs. A third benefit is some degree of creditor protection. States offer varying levels of creditor protection to traditional IRAs and Roth IRAs, while the federal government provides significant bankruptcy protection for traditional IRAs and Roth IRAs. 

IRA Annual Contribution Requirement: Earned Income

In order to make any of the three types of IRA annual contributions for any particular year, you or your spouse must have earned income during that year. Earned income is generally that income that is reported to you on your Form W-2, or is reported by you on your tax return on Schedule C (self-employment income). It also includes self-employment income reported to you on a Form K-1 (because you are a self-employed partner in a partnership). It does not include income reported to you on a Form K-1 from an S corporation.

While wages, nontaxable combat income, and self-employment income qualify as earned income for this purpose, several types of income do not. Social security, pensions, rentals, royalties, interest, and dividends are not earned income. Income excluded from taxable income under the foreign earned income exclusion also does not constitute “earned income” for IRA purposes.

Traditional Nondeductible IRA Annual Contributions

There’s are only one requirement to contribute to a traditional, nondeductible IRA for a taxable year:

• You and/or your spouse have earned income during that taxable year.

That’s it! As long as you satisfy that requirement, you can contribute to a traditional nondeductible IRA, no further questions asked.

Example: Teve Torbes is the publisher of a successful magazine. He is paid a salary of $1,000,000 in 2024 and is covered by the magazine’s 401(k) plan. Teve can make up to a $7,000 nondeductible contribution to a traditional IRA, and Teve’s wife can also make up to a $7,000 nondeductible contribution to a traditional IRA.

There is no tax deduction for contributing to a traditional nondeductible IRA. The amount of your nondeductible contribution creates “basis” in the traditional IRA. When you withdraw money from the traditional IRA in retirement, a ratable portion of the withdrawal is treated as a return of basis and thus not taxable (the “Pro-Rata Rule”).

Example: Ted makes a $6,000 nondeductible traditional IRA contribution for each of 10 years ($60,000 total). When he retires, the traditional IRA is worth $100,000, and he takes a $5,000 distribution from the traditional IRA. Ted is over 59 ½ when he makes the withdrawal. Of the $5,000 withdrawal, Ted will include $2,000 in his taxable income, because 60 percent ($3,000 — $60,000 basis divided by $100,000 fair market value times the $5,000 withdrawn) will be treated as a withdrawal of basis and thus tax free.

Traditional nondeductible IRA contributions generally give taxpayers a rather limited tax benefit. However, since 2010 traditional nondeductible IRA contributions have become an important tax planning tool because of the availability of the Backdoor Roth IRA.

Making a nondeductible IRA contribution requires the filing of a Form 8606 with your federal income tax return.

Traditional Deductible IRA Annual Contributions

In order to make a deductible contribution to a traditional IRA, three sets of qualification rules apply.

ONE: No Workplace Retirement Plan

Here are the qualification rules if neither you nor your spouse is covered by an employer retirement plan (401(k)s and the like and self-employment retirement plans):

• You and/or your spouse have earned income during that taxable year.

That’s it! As long as you satisfy that requirement and you and your spouse are not covered by an employer retirement plan, you can make a deductible contribution to a traditional IRA, no further questions asked.

Coverage by an employer retirement plan means either you or your employer contributed any amount to an employer retirement plan (on your behalf) during the taxable year. Coverage by an employer retirement plan includes coverage under a self-employment retirement plan.

Example: Teve Torbes is the publisher of a successful magazine. He and his wife are 45 years old. He is paid a salary of $1,000,000 in 2024. Neither he nor his wife is covered by an employer retirement plan. Teve can make up to a $7,000 deductible contribution to a traditional IRA, and Teve’s wife can also make up to a $7,000 deductible contribution to a traditional IRA.

TWO: You Are Covered by a Workplace Retirement Plan

Here are the deductible traditional IRA qualification rules if you are covered by an employer retirement plan:

• You and/or your spouse have earned income during that taxable year.
• Your modified adjusted gross income (“MAGI”) for 2024 is less than $87,000 (if single), $143,000 (if married filing joint, “MFJ”), or $10,000 (if married filing separate, “MFS”). 

Note that in between $77,000 and $87,000 (single), $123,000 and $143,000 (MFJ) and $0 and $10,000 (MFS), your ability to make a deductible contribution to a traditional IRA phases out ratably. Here is an illustrative example.

Example: Mike is 30 years old, single, and is covered by a 401(k) plan at work. Mike has a MAGI of $82,000 in 2024, most of which is W-2 income. Based on a MAGI in the middle of the phaseout range, Mike is limited to a maximum $3,500 deductible contribution to a traditional IRA.

Assuming he makes a $3,500 deductible IRA contribution, Mike has $3,500 worth of IRA contributions left. He can either, or a combination of both (up to $3,500) (a) make a contribution to a nondeductible traditional IRA, since he meets the qualification requirement to contribute to a nondeductible traditional IRA or (b) make a contribution to a Roth IRA, since he meets the qualification requirements (discussed below) to contribute to a Roth IRA. In such a case, Mike would be likely to favor a Roth IRA contribution over a nondeductible traditional IRA contribution.

THREE: Only Your Spouse is Covered by a Workplace Retirement Plan

Here are the deductible traditional IRA qualification rules if you are not covered by an employer retirement plan but your spouse is covered by an employer retirement plan:

• You and/or your spouse have earned income during that taxable year.
• Your MAGI for 2024 is less than $240,000 (MFJ) or $10,000 (MFS). 

Note that in between $230,000 and $240,000 (MFJ) and $0 and $10,000 (MFS), your ability to make a deductible contribution to a traditional IRA phases out ratably. 

Roth IRA Annual Contributions

Here are the Roth IRA annual contribution qualification rules.

• You and/or your spouse have earned income during that taxable year.
• Your MAGI for 2024 is less than $161,000 (single), $240,000 (MFJ), or $10,000 (MFS). 

Note that in between $146,000 and $161,000 (single), $230,000 and $240,000 (MFJ), and $0 and $10,000 (MFS), your ability to make a Roth IRA contribution phases out ratably. 

Notice that whether you and/or your spouse are covered by an employer retirement plan (including a self-employment retirement plan) is irrelevant. You and your spouse can be covered by an employer retirement plan and you can still contribute to a Roth IRA (so long as you meet the other qualification requirements).

Here is an example illustrating your options in the Roth IRA MAGI phaseout range.

Example: Mike is 30 years old, single, and covered by a workplace retirement plan. Mike has a MAGI of $155,000 for 2024, most of which is W-2 income. Based on a MAGI 60 percent through the phaseout range, Mike is limited to a maximum $2,800 contribution to a Roth IRA.

Assuming he makes a $2,800 annual Roth IRA contribution, Mike has $4,200 worth of IRA contributions left. He can make up to $4,200 in annual contributions to a nondeductible traditional IRA, since he meets the qualification requirement to contribute to a nondeductible traditional IRA.

IRA Annual Contribution Limits

For taxpayers younger than 50 years old during the entire year, the maximum (for 2024) that can be contributed to the combination of all three types of IRAs is the lesser of:

• The taxpayer’s and their spouse’s combined earned income, or
• $7,000.

Thus, if both spouses are younger than 50 years old, the maximum IRA contributions for a married couple is $14,000.

For taxpayers 50 years old or older during any part of the taxable year the maximum (for 2024) that can be contributed to the combination of all three types of IRAs is the lesser of:

• The taxpayer’s and their spouse’s combined earned income, or
• $8,000.

Thus, if both spouses are 50 or older, the maximum IRA contributions for a married couple is $16,000.

Deadlines

The deadline to make an IRA contribution for a particular year is April 15th of the year following the taxable year (thus, the deadline to make a 2024 IRA contribution is April 15, 2025). The deadline to make earned income for a taxable year is December 31st of that year.

Rollover Contributions

There’s a separate category of contributions to IRAs: rollover contributions. These can be from other accounts of the same type (traditional IRA to traditional IRA, Roth IRA to Roth IRA) or from a workplace retirement plan (for example, traditional 401(k) to traditional IRA, Roth 401(k) to Roth IRA). 

Rollover contributions do not require having earned income and have no income limits and should be generally tax-free. For a myriad of reasons, it is usually best to effectuate rollovers as direct trustee-to-trustee transfers. 

As a practical matter, it is often the case that IRAs serve at the retirement home for workplace retirement plans such as 401(k)s. 

Correction

A previous version of this blog post, titled “IRA Contributions for Beginners” erroneously stated that one must be a citizen or resident of the United States to make an IRA contribution. I regret the error. 

Further Reading

Deductible traditional IRA or Roth IRA? If you qualify for both, it can be difficult to determine which is better. I’ve written here about some of the factors to consider in determining whether a deductible traditional contribution or a Roth contribution is better for you.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

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This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.