IRA FAQs

What is an IRA?

 An individual retirement arrangement (IRA) is a special domestic trust, custodial account, or annuity endorsement established to hold assets for an individual’s retirement. An IRA is not a certificate of deposit, money market account, or any other type of investment.

What is the difference between a SEP IRA and a Traditional IRA?

 A simplified employee pension (SEP) plan allows employers to make discretionary contributions to an employee’s IRA. Once the employer or employee makes a SEP plan contribution to an IRA, the contribution becomes IRA assets subject to IRA rules and regulations.

Who is eligible to make Traditional IRA contributions?

Anyone with eligible compensation may contribute to a Traditional IRA. For 2019 and prior years, however, an IRA owner also had to be under age 70½. The SECURE Act removed this age restriction, effective January 1, 2020. Eligible compensation generally is what an individual earns from working (earned income from personal services rendered).

 What is the deadline for making a Traditional IRA contribution for a noncalendar-year taxpayer?

 IRA owners have until the deadline for filing their federal tax returns to make a Traditional I RA contribution regardless of whether they file on a non-calendar-year basis. Almost all individual taxpayers file on a calendar-year basis, and generally have until April 15 to make a Traditional IRA contribution. 

Can individuals age 70½ or older make contributions to Traditional IRAs?

Yes. Effective for 2020 and later tax years, IRA owners with eligible compensation can make Traditional IRA contributions at any age. 

What is the contribution limit for a Traditional IRA?

 An eligible individual may contribute the lesser of the annual contribution limit ($7,000 for 2024 and for 2025), or 100 percent of eligible compensation (generally, earned income), to an IRA. Also, IRA owners who are age 50 and older may make catch-up contributions of up to $1,000 annually. The contribution limit is an aggregate limit for all Traditional and Roth IRAs. So, the maximum amount that an individual may contribute to a Traditional IRA is reduced by any contributions the individual has made to other Traditional IRAs and to Roth IRAs for the same year. 

When must IRA owners begin taking money out of their Traditional IRAs?

 IRA owners must begin taking money out of their Traditional IRAs by April 1 of the year following the year in which they attain the applicable RMD age (also known as the IRA owner’s required beginning date). The minimum amount that the IRA owner must distribute for a given tax year is called the required minimum distribution (RMD). The SECURE 2.0 Act of 2022 increased the applicable RMD age again to age 73 in 2023 and to age 75 in 2033. Beginning in 2023, failure to remove an RMD results in an excess accumulation penalty tax equal to 25 percent of the amount that should have been withdrawn, and is further reduced to 10 percent if corrected timely. (Before 2023, the penalty tax was 50 percent of the amount that should have been withdrawn).

What are qualified charitable distributions?

 Qualified charitable distributions (QCDs) are distributions that an IRA owner or beneficiary who is age 70ó or older donates directly to qualified charitable organizations. These IRA distributions are tax-free and are limited to $105,000 for 2024 and $108,000 for 2025. They also may go toward satisfying an IRA owner’s or beneficiary’s RMD for the applicable year.

What is a Roth IRA?

 A Roth IRA is a type of IRA, first available January 1, 1998, where contributions are not deductible, but distributions (including earnings) can be tax-free if certain circumstances exist.

 Who is eligible to contribute to a Roth IRA?

To contribute to a Roth IRA, an individual (or an individual’s spouse) must have eligible compensation. Compensation for Roth IRAs is defined the same as for Traditional IRAs. In addition, a person’s modified adjusted gross income (MAGI) must fall within the applicable limits for her tax filing status. Unlike a Traditional IRA, there is no age limit for making contributions to a Roth IRA. 

What are the contribution limits for a Roth IRA? An eligible individual may contribute the lesser of the annual contribution limit ($7,000 for 2024 and for 2025), or 100 percent of eligible compensation (generally, earned income) to a Roth IRA. The maximum applies to all Traditional IRA and Roth IRA contributions made for the tax year, in aggregate. The contribution limit is subject to annual cost-of-living adjustments. Also, IRA owners who are age 50 and older may make catch-up contributions of up to $1,000 for 2024 and for 2025. What is the deadline for contributions to a Roth IRA? The contribution deadline is the taxpayer’s tax return due date (usually April 15), excluding extensions. But if the tax return due date falls on a Saturday, Sunday, or legal holiday, the IRA owner has until the following business day to make her contribution.

What are Coverdell Education Savings Accounts?

A Coverdell education savings account (ESA) is a savings arrangement in which contributions are invested for the purpose of funding a person’s education. ESAs were created by the Taxpayer Relief Act of 1997 and became available January 1, 1998, as a way to help fund higher education. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) brought several changes to ESAs effective January 1, 2002, making ESAs more appealing. This included, among other things, increased contributions, increased eligibility for contributors, and the ability to use ESA assets for primary and secondary education.

What are the benefits of ESAs? ESA contributions are not tax-deductible, but the earnings grow tax-deferred. ESAs provide a unique savings vehicle with the potential to have tax-free income to pay for education expenses. Tax-free distributions may be taken to pay for the person’s qualified education expenses at an eligible educational institution. Qualified education expenses can include certain elementary and secondary education expenses as well as postsecondary education expenses.

Who plays a role in the establishment and maintenance of an ESA? Numerous parties play an active role in establishing and maintaining ESAs, such as the financial organization, grantor/ depositor, designated beneficiary, responsible individual, contributor, and death beneficiary.

Financial Organization The financial organization (i.e., trustee or custodian) is the entity that maintains the ESA on behalf of the designated beneficiary. The financial organization must follow certain compliance requirements as defined by laws and by the IRS. Many of these requirements are detailed in the ESA plan agreement. Designated Beneficiary The designated beneficiary is the person for whom the ESA initially is established.

Grantor/Depositor

The grantor/depositor is the person who establishes the ESA with the financial organization for the benefit of the designated beneficiary. In most cases, the grantor/depositor is a parent, grandparent, or other close family member, but there is no requirement that the grantor/depositor bear any relationship to the designated beneficiary. The grantor/depositor names the responsible individual for the ESA.

Responsible Individual

The responsible individual usually is a parent or legal guardian of the designated beneficiary. The responsible individual directs the investments for the ESA contributions and directs the financial organization regarding all ESA transactions. Under certain circumstances, an election in the ESA plan agreement may allow the designated beneficiary to become the responsible individual upon reaching the age of majority.

Contributor

The grantor/depositor typically makes the first contribution when establishing the ESA, but the financial organization maintaining the ESA may accept contributions from any other person or entity. Designated beneficiaries also may fund their own ESAs.

Death Beneficiary

The death beneficiary is the person or entity named to receive the ESA assets upon the designated beneficiary’s death.

 What is the annual contribution limit for ESAs?

The annual maximum contribution per designated beneficiary is $2,000. A person (or entity) may contribute to ESAs on behalf of any number of designated beneficiaries. Because there might be multiple persons contributing to an ESA on behalf of one designated beneficiary, there is potential for a designated beneficiary to receive excess contributions.

What is the ESA contribution deadline?

Contributors must make ESA contributions by their tax return due date, not including extensions (generally April 15). Contributions made between January 1 and the tax return due date for the previous year are called “prior-year contributions.” Contributors must make written irrevocable elections to treat contributions as prior-year contributions.