Important Reminders

IRA interest.   Although interest earned from your IRA is generally not taxed in the year earned, it is not tax-exempt interest. Do not report this interest on your tax return as tax-exempt interest.

Form 8606.   If you make nondeductible contributions to a traditional IRA and you do not file Form 8606, Nondeductible IRAs, with your tax return, you may have to pay a $50 penalty.

Spousal IRAs.   In the case of a married couple filing a joint return, up to $3,000 ($3,500 if 50 or older) can be contributed to IRAs (other than SIMPLE IRAs) on behalf of each spouse, even if one spouse has little or no compensation. See Spousal IRA limit under How Much Can Be Contributed? and under Can I contribute to a Roth IRA for my spouse? under Roth IRAs, later.

Employer contributions under a SEP plan are not counted when figuring the limits just discussed. SEP plans are discussed in chapter 3 of Publication 590.

Spouse covered by employer plan.   If you are not covered by an employer retirement plan and you file a joint return, you may be able to deduct all of your contributions to a traditional IRA, even if your spouse is covered by a plan. See How Much Can I Deduct? under Traditional IRAs.

Distributions for higher education expenses.   You can take distributions from your traditional IRA or Roth IRA for qualified higher education expenses without having to pay the 10% additional tax on early distributions. For more information, see Publication 590.

Distributions for first home.   You can take distributions of up to $10,000 from your traditional or Roth IRA to buy, build, or rebuild a first home without having to pay the 10% additional tax on early distributions. For more information, see Publication 590.

Roth IRA.   You cannot claim a deduction for any contributions to a Roth IRA. But, if you satisfy the requirements, all earnings are tax free and neither your nondeductible contributions nor any earnings on them are taxable when you withdraw them. See Roth IRAs, later.

Introduction

An individual retirement arrangement (IRA) is a personal savings plan that offers you tax advantages to set aside money for your retirement.

This chapter discusses:

1. The rules for a traditional IRA (any IRA that is not a Roth or SIMPLE IRA), and
2. The Roth IRA, which features nondeductible contributions and tax-free distributions.

Simplified Employee Pensions (SEPs) and Savings Incentive Match Plans for Employees (SIMPLEs) are not discussed in this chapter. For more information on these plans and employees' SEP-IRAs and SIMPLE IRAs that are part of these plans, see Publication 590.

Useful Items You may want to see:

Publication

• 590   Individual Retirement Arrangements (IRAs)

Form (and Instructions)

• 5329   Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts
• 8606   Nondeductible IRAs

Traditional IRAs

In this chapter the original IRA (sometimes called an ordinary or regular IRA) is referred to as a traditional IRA. Two advantages of a traditional IRA are:

1. You may be able to deduct some or all of your contributions to it, depending on your circumstances, and,
2. Generally, amounts in your IRA, including earnings and gains, are not taxed until they are distributed.

What Is a Traditional IRA?

A traditional IRA is any IRA that is not a Roth IRA or a SIMPLE IRA.

Who Can Set Up a Traditional IRA?

You can set up and make contributions to a traditional IRA if:

1. You (or, if you file a joint return, your spouse) received taxable compensation during the year, and
2. You were not age 70½ by the end of the year.

What is compensation?   Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Scholarship and fellowship payments are compensation for this purpose only if shown in box 1 of Form W-2. Compensation also includes commissions and taxable alimony and separate maintenance payments.

Self-employment income.   If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the total of:

1. The deduction for contributions made on your behalf to retirement plans, and
2. The deduction allowed for one-half of your self-employment taxes.

Compensation includes earnings from self-employment even if they are not subject to self-employment tax because of your religious beliefs. See Publication 533, Self-Employment Tax, for more information.

What is not compensation?   Compensation does not include any of the following items.

• Earnings and profits from property, such as rental income, interest income, and dividend income.
• Pension or annuity income.
• Deferred compensation received (compensation payments postponed from a past year).
• Income from a partnership for which you do not provide services that are a material income-producing factor.
• Any amounts you exclude from income, such as foreign earned income and housing costs.

When and How Can a Traditional IRA Be Set Up?

You can set up a traditional IRA at any time. However, the time for making contributions for any year is limited. See When Can Contributions Be Made, later.

You can set up different kinds of IRAs with a variety of organizations. You can set up an IRA at a bank or other financial institution or with a mutual fund or life insurance company. You can also set up an IRA through your stockbroker. Any IRA must meet Internal Revenue Code requirements.

Kinds of traditional IRAs.   Your traditional IRA can be an individual retirement account or annuity. It can be part of either a simplified employee pension (SEP) or an employer or employee association trust account.

How Much Can Be Contributed?

There are limits and other rules that affect the amount that can be contributed and the amount you can deduct. These limits and other rules are explained below.

Community property laws.   Except as discussed later under Spousal IRA limit, each spouse figures his or her limit separately, using his or her own compensation. This is the rule even in states with community property laws.

Brokers' commissions.   Brokers' commissions paid in connection with your traditional IRA are subject to the contribution limit.

Trustees' fees.   Trustees' administrative fees are not subject to the contribution limit.

Contributions to your traditional IRAs reduce the limit for contributions to Roth IRAs. (See Roth IRAs, later.)

General limit.   The most that can be contributed to your traditional IRA is the smaller of the following amounts:

1. Your compensation (defined earlier) that you must include in income for the year, or
2. $3,000 ($3,500 if you are 50 or older).

This is the most that can be contributed regardless of whether the contributions are to one or more traditional IRAs or whether all or part of the contributions are nondeductible. (See Nondeductible Contributions, later.)

Example 1.   Betty, who is 34 years old and single, earned $24,000 in 2002. Her IRA contributions for 2002 are limited to $3,000.

Example 2.   John, a college student working part time, earned $1,500 in 2002. His IRA contributions for 2002 are limited to $1,500, the amount of his compensation.

Spousal IRA limit.   If you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your IRA is the smaller of the following amounts:

1. $3,000 ($3,500 if you are 50 or older), or
2. The total compensation includible in the gross income of both you and your spouse for the year, reduced by the following two amounts.
   1. Your spouse's contribution for the year to a traditional IRA.
   2. Any contribution for the year to a Roth IRA on behalf of your spouse.

This means that the total combined contributions that can be made for the year to your IRA and your spouse's IRA can be as much as $6,000 ($6,500 if only one of you is 50 or older, or $7,000 if both of you are 50 or older).

When Can Contributions Be Made?

As soon as you set up your traditional IRA, contributions can be made to it through your chosen sponsor (trustee or other administrator). Contributions to a traditional IRA must be in the form of money (cash, check, or money order). Property cannot be contributed.

Contributions must be made by due date.   Contributions can be made to your traditional IRA for a year at any time during the year or by the due date for filing your return for that year, not including extensions. For most people, this means that contributions for 2002 must be made by April 15, 2003.

Age 70½ rule.   Contributions cannot be made to your traditional IRA for the year in which you reach age 70½ or for any later year.

Designating year for which contribution is made.   If an amount is contributed to your traditional IRA between January 1 and April 15, you should tell the sponsor which year (the current year or the previous year) the contribution is for. If you do not tell the sponsor which year it is for, the sponsor can assume, and report to the IRS, that the contribution is for the current year (the year the sponsor received it).

Filing before a contribution is made.   You can file your return claiming a traditional IRA contribution before the contribution is actually made. However, the contribution must be made by the due date of your return, not including extensions.

Contributions not required.   You do not have to contribute to your traditional IRA for every tax year, even if you can.

How Much Can I Deduct?

Generally, you can deduct the lesser of:

• The contributions to your traditional IRA for the year, or
• The general limit (or the spousal IRA limit, if it applies).

However, if you or your spouse was covered by an employer retirement plan, you may not be able to deduct this amount. See Limit if Covered by Employer Plan, later.

You may be eligible to claim a credit for contributions to your traditional IRA. For more information see chapter 38.

Trustees' fees.   Trustees' administrative fees that are billed separately and paid in connection with your traditional IRA are not deductible as IRA contributions. However, they may be deductible as a miscellaneous itemized deduction on Schedule A (Form 1040). See chapter 30.

Brokers' commissions.   Brokers' commissions are part of your IRA contribution and, as such, are deductible subject to the limits.

Full deduction.   If neither you nor your spouse was covered for any part of the year by an employer retirement plan, you can take a deduction for total contributions to one or more traditional IRAs of up to the lesser of:

1. $3,000 ($3,500 if you are 50 or older), or
2. 100% of your compensation.

This limit is reduced by any contributions made to a 501(c)(18) plan on your behalf.

Spousal IRA.   In the case of a married couple with unequal compensation who file a joint return, the deduction for contributions to the traditional IRA of the spouse with less compensation is limited to the lesser of:

1. $3,000 ($3,500 if 50 or older), or
2. The total compensation includible in the gross income of both spouses for the year reduced by the following two amounts.
   1. The IRA deduction for the year of the spouse with the greater compensation.
   2. Any contributions for the year to a Roth IRA on behalf of the spouse with more compensation.

This limit is reduced by any contributions to a 501(c)(18) plan on behalf of the spouse with less compensation.

Note.   If you were divorced or legally separated (and did not remarry) before the end of the year, you cannot deduct any contributions to your spouse's IRA. After a divorce or legal separation, you can deduct only contributions to your own IRA and your deductions are subject to the rules for single individuals.

Covered by an employer retirement plan.   If you or your spouse was covered by an employer retirement plan at any time during the year for which contributions were made, your deduction may be further limited. This is discussed later under Limit If Covered by Employer Plan. Limits on the amount you can deduct do not affect the amount that can be contributed. See Nondeductible Contributions, later.

Are You Covered by an Employer Plan?

The Form W-2 you receive from your employer has a box used to indicate whether you were covered for the year. The Retirement plan box should be checked if you were covered.

Reservists and volunteer firefighters should also see Situations in Which You Are Not Covered, later.

If you are not certain whether you were covered by your employer's retirement plan, you should ask your employer.

Federal judges.   For purposes of the IRA deduction, federal judges are covered by an employer retirement plan.

For Which Year(s) Are You Covered?

Special rules apply to determine the tax years for which you are covered by an employer plan. These rules differ depending on whether the plan is a defined contribution plan or a defined benefit plan.

Tax year.   Your tax year is the annual accounting period you use to keep records and report income and expenses on your income tax return. For most people, the tax year is the calendar year.

Defined contribution plan.   Generally, you are covered by a defined contribution plan for a tax year if amounts are contributed or allocated to your account for the plan year that ends with or within that tax year.

A defined contribution plan is a plan that provides for a separate account for each person covered by the plan. Types of defined contribution plans include profit-sharing plans, stock bonus plans, and money purchase pension plans.

Defined benefit plan.   If you are eligible to participate in your employer's defined benefit plan for the plan year that ends within your tax year, you are covered by the plan. This rule applies even if you:

• Declined to participate in the plan,
• Did not make a required contribution, or
• Did not perform the minimum service required to accrue a benefit for the year.

A defined benefit plan is any plan that is not a defined contribution plan. Types of defined benefit plans include pension plans and annuity plans.

No vested interest.   If you accrue a benefit for a plan year, you are covered by that plan even if you have no vested interest in (legal right to) the account or the accrual.

Situations in Which You Are Not Covered

Unless you are covered under another employer plan, you are not covered by an employer plan if you are in one of the situations described below.

Social security or railroad retirement.   Coverage under social security or railroad retirement is not coverage under an employer retirement plan.

Benefits from a previous employer's plan.   If you receive retirement benefits from a previous employer's plan, you are not covered by that plan.

Reservists.   If the only reason you participate in a plan is because you are a member of a reserve unit of the armed forces, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.

1. The plan you participate in is established for its employees by:
   1. The United States,
   2. A state or political subdivision of a state, or
   3. An instrumentality of either (a) or (b) above.
2. You did not serve more than 90 days on active duty during the year (not counting duty for training).

Volunteer firefighters.   If the only reason you participate in a plan is because you are a volunteer firefighter, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.

1. The plan you participate in is established for its employees by:
   1. The United States,
   2. A state or political subdivision of a state, or
   3. An instrumentality of either (a) or (b) above.
2. Your accrued retirement benefits at the beginning of the year will not provide more than $1,800 per year at retirement.

Limit if Covered by Employer Plan

If either you or your spouse was covered by an employer retirement plan, you may be entitled to only a partial (reduced) deduction or no deduction at all, depending on your income and your filing status.

Your deduction begins to decrease (phase out) when your income rises above a certain amount and is eliminated altogether when it reaches a higher amount. These amounts vary depending on your filing status.

To determine if your deduction is subject to phaseout, you must determine your modified adjusted gross income (AGI) and your filing status. Then use Table 18-1 or 18-2 to determine if the phaseout applies.

Social security recipients.   Instead of using Table 18-1 or 18-2, use the worksheets in Appendix B of Publication 590 if, for the year, all of the following apply.

• You received social security benefits.
• You received taxable compensation.
• Contributions were made to your traditional IRA.
• You or your spouse was covered by an employer retirement plan.

Use those worksheets to figure your IRA deduction, your nondeductible contribution, and the taxable portion, if any, of your social security benefits.

Deduction phaseout.   If you were covered by an employer retirement plan and you did not receive any social security retirement benefits, your IRA deduction may be reduced or eliminated depending on your filing status and modified AGI as shown in Table 18-1 .

If you are covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.

Table 18-1.  Effect of Modified AGI ¹ on Deduction if Covered by Retirement Plan at Work

IF your filing status is...	AND your modified AGI is...	THEN you can take...
single or head of household	less than $34,000	a full deduction.
	at least $34,000 but less than $44,000	a partial deduction.
	$44,000 or more	no deduction.
married filing jointly or qualifying widow(er)	less than $54,000	a full deduction.
	at least $54,000 but less than $64,000	a partial deduction.
	$64,000 or more	no deduction.
married filing separately 2	less than $10,000	a partial deduction.
	$10,000 or more	no deduction.

1Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI).

2If you did not live with your spouse at any time during the year, your filing status is considered Single for this purpose (therefore, your IRA deduction is determined under the Single column).

For 2003, if you are covered by a retirement plan at work, your IRA deduction will not be reduced (phased out) unless your modified AGI is between:

• $40,000 and $50,000 for a single individual (or head of household),
• $60,000 and $70,000 for a married couple filing a joint return (or a qualifying widow(er)), or
• $-0- (no increase) and $10,000 for a married individual filing a separate return.

For all filing statuses other than married filing separately, the upper and lower limits of the phaseout range will increase by $6,000.

If your spouse is covered.If you are not covered by an employer retirement plan, but your spouse is, and you did not receive any social security benefits, your IRA deduction may be reduced or eliminated entirely depending on your filing status and modified AGI as shown in Table 18-2.

If you are not covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.

Table 18-2.  Effect of Modified AGI ¹ on Deduction if NOT Covered by Retirement Plan at Work

IF your filing status is...	AND your modified AGI is...	THEN you can take...
single,head of household, or qualifying widow(er)	any amount	a full deduction.
married filing jointly or separately with a spouse who is not covered by a plan at work	any amount	a full deduction.
married filing jointly with a spouse who is covered by a plan at work	less than $150,000	a full deduction.
	at least $150,000 but less than $160,000	a partial deduction.
	$160,000 or more	no deduction.
married filing separately with a spouse who is covered by a plan at work 2	less than $10,000	a partial deduction.
	$10,000 or more	no deduction.

1Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI).

2You are entitled to the full deduction if you did not live with your spouse at any time during the year.

Filing status.   Your filing status depends primarily on your marital status. For this purpose, you need to know if your filing status is single or head of household, married filing jointly or qualifying widow(er), or married filing separately. If you need more information on filing status, see chapter 2.

Lived apart from spouse.   If you did not live with your spouse at any time during the year and you file a separate return, your filing status, for this purpose, is single.

Modified adjusted gross income (AGI).   How you figure your modified AGI depends on whether you are filing Form 1040 or Form 1040A. If you made contributions to your IRA for 2002 and received a distribution from your IRA in 2002, see Publication 590.

Do not assume that your modified AGI is the same as your compensation. Your modified AGI may include income in addition to your compensation (discussed earlier), such as interest, dividends, and income from IRA distributions.

Form 1040.   If you file Form 1040, refigure the amount on page 1 adjusted gross income line without taking into account any of the following amounts.

• IRA deduction.
• Student loan interest deduction.
• Tuition and fees deduction.
• Foreign earned income exclusion.
• Foreign housing exclusion or deduction.
• Exclusion of qualified savings bond interest shown on Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989 (For Filers With Qualified Higher Education Expenses).
• Exclusion of employer-paid adoption expenses shown on Form 8839, Qualified Adoption Expenses.

This is your modified AGI.

Form 1040A.   If you file Form 1040A, refigure the amount on page 1 adjusted gross income line without taking into account any of the following amounts.

• IRA deduction.
• Student loan interest deduction.
• Tuition and fees deduction.
• Exclusion of qualified savings bond interest shown on Form 8815.
• Exclusion of employer-paid adoption expenses shown on Form 8839.

This is your modified AGI.

Both contributions for 2002 and distributions in 2002.   If all three of the following occurred, any IRA distributions you received in 2002 may be partly tax free and partly taxable.

1. You received distributions in 2002 from one or more traditional IRAs.
2. You made contributions to a traditional IRA for 2002.
3. Some of those contributions may be nondeductible contributions depending on whether your IRA deduction for 2002 is reduced.

If all three of the above occurred, you must figure the taxable part of the traditional IRA distribution before you can figure your modified AGI. To do this, you can use Worksheet 1-3, Figuring the Taxable Part of Your IRA Distribution in Publication 590.

If at least one of the above did not occur, figure your modified AGI using Worksheet 18-1 in this chapter.

How to figure your reduced IRA deduction.   You can figure your reduced IRA deduction for either Form 1040 or Form 1040A by using the worksheets in chapter 1 of Publication 590. Also, the instructions for Form 1040 and Form 1040A include similar worksheets that you may be able to use instead.

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