As we approach the 2024 and 2025 tax years, it's essential to understand the contribution limits and deadlines for Individual Retirement Accounts (IRAs). Proper planning can maximize your retirement savings and help you avoid potential tax issues.
IRA Contribution Limits for 2024 and 2025
For both 2024 and 2025, the IRS has set the following contribution limits for Traditional and Roth IRAs:
Individuals under 50 years old: Up to $7,000 per year.
Individuals aged 50 and above: An additional "catch-up" contribution of $1,000, totaling up to $8,000 per year.
These limits apply collectively to all your IRAs; for instance, if you have both a Traditional and a Roth IRA, your combined contributions to both accounts cannot exceed the annual limit.
Contribution Deadlines
You have until the federal tax filing deadline to make contributions for the previous tax year. For the 2024 tax year, contributions can be made until April 15, 2025. Similarly, for the 2025 tax year, the deadline is April 15, 2026. Making contributions before these deadlines allows you to maximize your retirement savings for each respective year.
Income Limits for Roth IRA Contributions
Eligibility to contribute to a Roth IRA depends on your Modified Adjusted Gross Income (MAGI) and tax filing status. The income thresholds for full or partial contributions are as follows:
For 2024:
Single Filers:
Full contribution: MAGI less than $146,000.
Partial contribution: MAGI between $146,000 and $161,000.
Ineligible: MAGI over $161,000.
Married Filing Jointly:
Full contribution: MAGI less than $230,000.
Partial contribution: MAGI between $230,000 and $240,000.
Ineligible: MAGI over $240,000.
For 2025:
Single Filers:
Full contribution: MAGI less than $150,000.
Partial contribution: MAGI between $150,000 and $165,000.
Ineligible: MAGI over $165,000.
Married Filing Jointly:
Full contribution: MAGI less than $236,000.
Partial contribution: MAGI between $236,000 and $246,000.
Ineligible: MAGI over $246,000.
It's crucial to assess your income annually to determine your eligibility for Roth IRA contributions, as exceeding these limits can lead to excess contributions, which may incur penalties.
Compensation for IRA Contribution Purposes
For purposes of contributing to an IRA, compensation is earnings from work, whether as an employee or self-employed. Compensation includes the following types of income.
Wages, salaries, tips, professional fees, bonuses, commissions, military differential pay, and any other taxable amounts included in box 1 of a Form W-2 (e.g., scholarships, fellowships, and stipends).
Net earnings from self-employment as a sole proprietor or a partner of a partnership, reduced by the deduction for one-half of self-employment (SE) tax and any deductions for contributions to a qualified retirement plan. Net SE earnings also include income not subject to SE tax due to a religious election to be excluded from Social Security coverage.
Taxable alimony and separate maintenance payments received under a decree of divorce or separate maintenance (for agreements finalized before 2019)
Nontaxable combat pay (code Q, box 12, Form W-2)
Taxable non-tuition fellowship and stipend payments made to aid the taxpayer in the pursuit of graduate or postdoctoral study and included in his or her gross income.
Compensation Does Not Include the Following Types of Income
Rental income and real estate earnings
Interest and dividends
Capital gains from the sale of investments or property
Pension or annuity income
Social Security benefits
Unemployment compensation
Gifts or inheritances
If you employ your children in your business and they receive legitimate wages, that income qualifies them to contribute to an IRA. This is a smart way to kickstart their retirement savings early while leveraging tax advantages.
Avoiding Common Pitfalls: Roth IRA Contributions and Income Limits
A common issue arises when individuals inadvertently contribute to a Roth IRA despite having income that exceeds the allowable limits. Such excess contributions can result in a 6% penalty on the amount over the limit for each year it remains in the account. To prevent this, it's essential to:
Calculate Your MAGI Accurately: Ensure you include all relevant income sources and adjustments.
Review IRS Guidelines Annually: Income limits and contribution rules can change, so stay informed.
Consider Alternative Strategies: If your income exceeds Roth IRA limits, you might explore a "backdoor" Roth IRA conversion, which involves contributing to a Traditional IRA and then converting those funds to a Roth IRA. This strategy has specific tax implications and may not be suitable for everyone. The "Backdoor Roth" IRA is a popular strategy that allows high-income earners to contribute to a Roth IRA by first making a non-deductible contribution to a Traditional IRA and then converting it to a Roth IRA. While this can be an effective way to bypass income limits, it comes with complexities that, if misunderstood, can lead to unexpected taxable income. For example, failing to account for the pro-rata rule—which considers all your IRA balances when calculating taxes on the conversion—can result in a higher tax bill than anticipated. It's crucial to fully understand the rules or consult with a Lucrum Legal Accounting™ team member before executing a Backdoor Roth to avoid costly mistakes.
Determining whether a Traditional or Roth IRA is more suitable for your financial situation can be complex, especially with varying income levels and tax considerations. Please reach out to us so we can provide personalized advice tailored to your circumstances, ensuring you make informed decisions about your retirement savings.
Comments