Money Girl

9 Retirement Account Rules Everyone Should Know

Episode Summary

9 critical retirement account rules that you should know.

Episode Notes

Laura answers listener questions and helps you get familiar with 9 critical retirement account rules so you can use them whether you’re employed, self-employed, unemployed, or retired.

Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.

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Episode Transcription

A Money Girl listener named Sue P. says, "I get such a benefit from your easy-to-understand explanations! I'm 68 and work full time with no intention of retiring for many years. Since I have to pay additional income tax this year, I'm thinking about contributing to a traditional IRA to avoid it. How would that affect the requirement to withdraw money at age 72? And can you contribute to a traditional IRA after age 72?"

And Dr. Sarah L. says, "Do you have any advice on the difference between a TIAA-CREF pre-tax and a TIAA-CREF Roth post-tax option for retirement contributions?"

Thanks so much for those excellent retirement account questions, Sue and Dr. Sarah!

I'm a fan of using retirement accounts because they come with tax advantages that make your money go further.

The only downside is that you must follow some strict account rules. And while they might seem confusing at first, I'm going to cover nine of the most critical retirement account rules everyone should know, no matter if you're employed, self-employed, unemployed, or retired. And along the way, I'll answer Sue and Dr. Sarah's questions.

Hey, friends! I'm Laura Adams, and I'm glad you downloaded the show. If you're new here, I'm an award-winning personal finance author and have hosted Money Girl since 2008. I also work with select brands as an on-camera PR spokesperson, consumer advocate, voice-over talent, and multimedia creator.

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Today's episode is number 740, called 9 Retirement Account Rules Everyone Should Know.

Let's get started!

The first rule everyone should know is that you must have earned income to contribute to a retirement account.

That includes workplace plans, such as a 401(k), self-employed plans like a SEP-IRA, or individual retirement accounts or IRAs. You can put money in a tax-advantaged account If you have taxable compensation during the year, such as salaries, wages, tips, bonuses, commissions, or self-employment income.

Note that I didn't mention investment income! So if you're living solely on investment earnings, you're not qualified to add funds to a retirement account.

The amount you can contribute to an IRA equals your taxable compensation up to $6,000 (or $7,000 if you're 50 or older) in 2022. What's really great is that minors can start saving for retirement as soon as they get their first jobs, such as a part-time weekend gig or full-time summer work.

Other retirement accounts have higher annual limits. For instance, for 2022, you can contribute up to $20,500 (or $27,000 if you're over age 50) to a 401(k) or 403(b) offered by an employer.

The second rule is that spouses without earned income can have an IRA.

This rule is an exception to the previous rule and is known as a spousal IRA. If you're married, file a joint tax return, and only one of you has annual compensation, the non-working spouse can still max out an IRA using household income.

For example, if you're a married, stay-at-home parent under age 50, you can contribute up to $6,000 in an IRA. Or, if you're unemployed and over 50, you could use your household income to contribute up to $7,000 in an IRA.

Rule number three is that you can't own a retirement account jointly.

Tax-advantaged retirement accounts can only be owned by an individual, even when you're married. There's no such thing as a jointly owned IRA or 401(k). Each retirement account owner must qualify to make contributions based on their income, except for the spousal IRA I just covered.

However, a minor's parents can make contributions on a child's behalf, up to the allowable limits–even if the funds come from a parent’s bank account. But you can't deposit funds in someone else's retirement account if they don't qualify for it in the first place.

Rule four is that you can contribute to more than one retirement account.

You can open up and contribute to as many tax-advantaged retirement accounts that you qualify for. They might include a traditional IRA, Roth IRA, workplace plans, and accounts for the self-employed, such as a solo 401(k) or SEP-IRA.

However, your total contributions can't exceed your annual allowable limit per account type. For example, if you have at least $6,000 in earned income and are under age 50, you could contribute $2,000 to a traditional IRA and $4,000 to a Roth IRA in the same year. But you can't put $6,000 in both of them.

You can even max out an IRA and a retirement account at work in the same year. However, when you (or a spouse) have a workplace account, your tax deduction for traditional IRA contributions may get reduced or eliminated, depending on your income.

RELATED: Can You Contribute to a 401(k) and an IRA in the Same Year? 

The fifth rule is that contributions to traditional retirement accounts are tax-deductible.

Traditional or regular accounts, such as a traditional IRA or 401(k), allow you to make pre-tax contributions. In other words, you don't pay tax on the money you contribute in the current year. Instead, taxes on contributions and earnings get deferred until you make withdrawals in the future.

That's what Sue asked about. And I definitely recommend contributing to a traditional retirement account at work or a traditional IRA as a legitimate way to cut your taxes.

She also asked how it would affect the requirement to withdraw money at age 72. Sue, it wouldn't change anything–you would still have to begin RMDs from an IRA or workplace retirement plan no later than April 1 following the year you turn 72.

Your retirement RMD changes yearly depending on your age in a table provided by the IRS. For example, an 80-year-old with $100,000 in an IRA at the end of last year would have to take out at least $4,950.50 this year.

Sue also asked if you could contribute to a traditional IRA after age 72. The answer is that you can make contributions for as long as you have earned income, even when you take RMDs. Remember that investment income doesn't count for retirement account eligibility.

Number six is that contributions to Roth retirement accounts are not tax-deductible.

Roth workplace accounts and those for the self-employed and individuals require you to pay tax upfront on contributions, so they're not tax-deductible. However, both your contributions and earnings can be withdrawn completely tax-free in retirement.

Like with a traditional IRA, you can make Roth IRA contributions at any age, as long as you have earned income. But unlike a traditional account or even Roth at work, you never have required minimum distributions with a Roth IRA. That means you can keep money in a Roth IRA as long as you like or pass it to your heirs.

Let's go back to the question from Dr. Sarah about the difference between a TIAA-CREF pre-tax and a TIAA-CREF Roth post-tax option for retirement contributions.

TIAA and CREF stand for Teachers Insurance and Annuity Association of America and College Retirement Equities Fund. The organization was created in 1918 to provide a secure retirement income for teachers, employees of colleges, and other nonprofit organizations. So, it's similar to a 401(k) or 403(b) but functions more like a pension plan, providing lifetime income for participants.

Dr. Sarah, when choosing a pre- or post-tax retirement option, there are several considerations. One is whether your future tax liability will be higher or lower than today. If you believe your income will be higher or the country's tax rate will go up by the time you retire, it's better to pay a lower tax rate on less income now using a Roth.

But if you believe your income or tax rate in retirement will be lower than today, it's better to use a traditional retirement account. Also, if you need a tax break in the current year due to a high household income, it can be wise to get tax deductions for traditional contributions.

And if you're unsure which direction to go, you can always put half of your contributions in a traditional account and half in a Roth. Having some tax-free income from a Roth in retirement is a valuable benefit.

Retirement rule seven is that you can't contribute to a Roth IRA if your income exceeds a limit.

Since the benefits of a Roth IRA are so good, those with high incomes get excluded. Your contributions get reduced or eliminated when your income exceeds annual thresholds. But that rule doesn’t apply to any other type of retirement account, including a Roth 401(k) or Roth 403(b). You can be the highest-paid employee at your company and still qualify for a workplace Roth account.

For 2022, single taxpayers can no longer make Roth IRA contributions when their modified adjusted gross income (MAGI) is $144,000 or higher. Joint filers get locked out when your household MAGI reaches $214,000.

However, it's not a problem if you previously contributed to a Roth IRA but now don't qualify. You can manage it and allow it to grow, but you can't make any new contributions. And if your income falls below the income cutoff in the future, you can make Roth IRA contributions again.

Retirement rule eight is that you can withdraw Roth contributions penalty-free.

In general, distributions from a retirement account before age 59.5 are subject to taxes plus an additional 10% early withdrawal penalty. However, since you pay tax upfront on Roth contributions, you can withdraw them penalty-free.

But withdrawals of Roth earnings before age 59.5 and before the account is five years old would be subject to tax and the 10% penalty. However, you avoid tax and a penalty (when you satisfy the five-year waiting period) if you spend a withdrawal on the following exceptions:

And lastly, number nine is that you have extra time to make specific retirement account contributions.

You have until April 15 or the next business day following the tax year to contribute to individual or self-employed retirement accounts, such as an IRA and SEP-IRA. For example, if you want to fund your IRA for 2022, you have until April 17, 2023.

However, workplace retirement plans only allow contributions in the current year. Therefore, your final contribution to a 401(k) for 2022 must be before December 31, 2022.

Remember that it's up to you whether you want to contribute to a retirement account. If you don't make contributions, your account stays open indefinitely. But aiming to max out as many retirement accounts as you qualify for is the absolute best way to create a secure financial future.

Before we go, I want to invite you to connect with me onTwitter @lauraadams or Instagram @lauradadams . And is my personal site where you can use my contact page and learn more about my work, books, and money courses.

That's all for now. I'll talk to you next week. Until then, here's to living a richer life.