How much can you Contribute to an Ira in 2011

In 2011, you can contribute $5,000 to an IRA, or, if you are over 50, you can contribute $6,000.  Considering contributing to an IRA means that you are thinking of the future, and it opens up a lot of choices for you in terms of how much you want to contribute, and also how much you are allowed to contribute. 

Discussions on IRAs are confusing, not only because there are different types of IRAs, but because the discussions about contributions are different from, but relevant to, discussions about deductions from income in the year of the contributions. There are also additional topics, such as the distributions from IRAs, and possibilities of penalty and taxation of distributed benefits that add to the general labyrinth of rules and regulations for IRAs.

Many people, looking for a tax break in April, contribute to an IRA so that they can deduct the contribution from their current taxable income, without considering other ramifications of their investment, like early distributions if they have put away money that they actually need for current living expenses. It’s important, when considering how much you can contribute to an IRA, to budget realistically, and think about not only the legal amounts that you can contribute, but also what you can actually afford to contribute. Penalties for contributing too much can be expensive. Early distributions from sheltered retirement income can be expensive, as well, including a 10% penalty on taxable distributions that don’t qualify for a myriad of possible exceptions.

The first consideration in deciding how much you can legally contribute is to figure out what your taxable compensation for the year has been.  “Compensation” is, roughly, earned income.  To decide what exactly is and isn’t compensation for the purposes of IRA contributions, refer to IRS Publication 590, Individual Retirement Arrangements, page 8. 

The lower limit for contributing to an IRA is your taxable compensation, that is, if you only made $2,000, then you can’t contribute $3,000 unless you are married to someone with higher compensation, and you are filing a joint return.

For 2011, if you have adequate taxable compensation that is not further constricted by “Modified Adjusted Gross Income Limitations for the purposes of IRA Contributions,” you can contribute up to $5000, or, if you are over 50 at the end of the tax year, you can contribute $6,000.  In IRS Publication 590, see Worksheet 1-1. Figuring Your Modified AGI, on page 16.  If you are considering a Roth IRA, see a similar worksheet on page 59.

There are many categories of IRAs, but the main division is between traditional IRAs and Roth IRAs.  There is no upper limit on income that would stop you from contributing to a traditional IRA (although income limits and other factors can stop you from deducting the contribution from current income at tax time.) The advantage to all sheltered retirement income is that the interest (or other sort of allowed unearned income) is not taxed until it is distributed, when, theoretically, you have a lower AGI than when you are still working. This allows you to accumulate a nest-egg that you can use when your income is lower in the later years of your life.  Your tax bracket will be lower, and you will therefore pay less tax than if you had paid taxes on the interest income in a regular savings account or on ordinary dividend income at the time that it was accumulated. 

Qualified employer sponsored plans, such as 401-k plans, give the additional advantage of sheltering the original contributions from taxation in the year of investment, so that gives an added advantage to the wage earner at tax time.  Traditional IRAs, within limits, share this advantage, depending on the income levels of the taxpayers and whether or not they or their spouse are participants in an employer-sponsored plan.  In this situation, the entire distribution, instead of just the interest, is taxable upon distribution, because the original contribution has never been taxed.  Because some people consider IRAs as a tax strategy only at the time of contribution, they only contribute what can be deducted from current income. But even if the contribution is not deductible, you can still make the contribution and, by filing form 8606 you can document your basis in the traditional IRA so that money that has already been taxed (not deducted in the year of contribution) can be non-taxable in the year of distribution.  Page 40 of Publication 590 discusses how to report a non-taxable distribution of a traditional IRA.  Studying the form itself is useful as well.  If you don’t file the 8606 when you make a non-deductible contribution, then the entire IRA distribution will be taxable.  See Form 8606 and Instructions for Form 8606 on the IRS website,

And just in case you aren’t confused yet, we have not yet discussed the important differences between the Roth and traditional IRAs. A Roth must be designated from the beginning as a Roth.  The contributions have the same lower limits as the traditional, but there are upper income limits to a Roth.  If you are single, head of household, or married filing separately and did not live with your spouse all year, and make between 56,000 and 122,000, your ability to contribute to a Roth will be phased out to zero at the upper limit. If you are married filing jointly, or a qualified widower, these limits are between 90,000 and 179,000.  If you are married filing separately and lived with your spouse at any time during the year, you cannot contribute to a Roth if you make more than 10,000.  See “Worksheet 2-2, Determining Your Reduced Roth IRA Contribution Limit” on page 60 of IRS Publication 590. Roth contributions are never deductible, and the interest or other allowed accumulations on the sheltered income is not taxable for qualified distributions. This makes Roth IRAs both unique and desirable for those who can afford to make non-deductible contributions.  But the $5,000/$6,000 limit is for total contributions to IRAs of all types.

For those who make too much money to legally contribute to a Roth, and for those who are also covered by a qualified plan at work, the alternative choice is to make non-deductible contributions to a traditional IRA, so that even though the interest will be taxable upon distribution, the basis will not be taxed because it was taxed before it was contributed.

With recent stock market losses in mind, many people have “rethought” the advantages of a Roth.  It’s bad enough to lose money that you have never paid taxes on, as in the 401-k plans, and similar plans, and traditional IRAs.  But with the Roth, you are risking money that has been fully taxed already, and there is never a guarantee that the accumulated unearned income will be there after the distribution qualifies.  Relevant questions would involve whether or not the deductibility of traditional IRAs is “on the table” as tax reform is being discussed in Congress. Some say that the best tax strategy is to take advantage of what is currently available. Others are certain that the advantage of tax-free interest (which is different than tax-exempt interest) is worth the risk in these uncertain times.