How do untruths about IRAs get started? Probably somewhere along the way someone who wasn’t fluent in IRS-speak misinterpreted a few of the rules. Erroneous information was repeated. Fallacies were mistaken for facts. Unfortunately, these half-truths continue to cause countless savers to miss out on years of investment growth.
It’s time to set the record straight. Here are some common myths that lead people to assume that an IRA just isn’t for them:
1. The IRS doesn’t let you contribute to a 401(k), Roth IRA and a traditional IRA in the same year.
The IRS doesn’t allow a lot of things (like claiming your kid’s guinea pig as a dependent), but going back for thirds at the retirement account salad bar isn’t one of them, as long as you stay within the allowable annual contribution limits. In an employer-sponsored retirement plan (a 401(k), 403(b), 457 or Thrift Savings Plan), you’re allowed to contribute $18,000, plus an additional $6,000 if you are age 50 or older. On top of that, if you are eligible to contribute to both a traditional and a Roth IRA, you can divert money into each in the same year as long as the total combined amount does not exceed the maximum annual allowable contribution limit of $5,500 (plus a $1,000 catch-up contribution if you’re 50 or older). Add it up and a serious saver could sock away as much as $23,500 a year, or up to $30,500 for those age 50 and older.
2. If you make too much money you can’t contribute to an IRA.
It’s true that you are ineligible to contribute to a Roth IRA at all if you earn “too much” in the IRS’ eyes ($196,000 or more if you are married and filing jointly or $133,000 for single filers in 2017). However, even those who pull in a massive annual paycheck are allowed to open and fund a traditional IRA. But here’s the caveat that can make the rules more confusing: Your household income as well as whether you or your spouse have access to a workplace retirement plan — e.g., a 401(k) — affect how much of your traditional IRA contribution the IRS will allow you to deduct from your taxes.
3. If you don’t qualify for a deductible IRA it’s not worth it to fund the account.
The traditional IRA’s upfront tax deduction gets all the glory, but that doesn’t mean there’s nothing in it for you if you don’t qualify to take that deduction. Remember, investments within IRAs grow tax-deferred. That’s true even for nondeductible IRAs. In other words, you don’t have to pay income tax on any investments in the account that produce dividends, interest or capital gains until you withdraw the money in retirement.
Another situation where a nondeductible IRA will help you save on taxes is if you decide to convert the IRA into a Roth (via the backdoor Roth IRA strategy.) When you make the conversion, the only money subject to income taxes will be any investment gains within the IRA before the conversion.
4. Nonworking (or low income-earning) spouses can’t contribute to an IRA.
The IRS clearly states that you must have earned income in order to be eligible to contribute to an IRA. But there is an exception to this rule: the spousal IRA. If you are, for example, a stay-at-home parent and are married to someone who is earning money and file a joint tax return, contributions to a Roth or traditional IRA can be made on your behalf. The IRA must be set up in the nonworking spouse’s name, and eligibility and deductibility are based on what applies to the spouse with greater compensation.
5. You are not allowed to touch the money you put in an IRA until retirement.
You really shouldn’t. Remember, the “R” in IRA stands for retirement, and in most cases dipping into the account before age 59½ results in a 10 percent early withdrawal penalty and, potentially, an income tax IOU from Uncle Sam. But if you are skipping out on the IRA because you don’t want to give up access to your money, you should know that there are exceptions to the no-touch rule. Both the Roth and traditional IRA waive the early withdrawal penalty for a first-time home purchase and to pay for certain qualified higher education expenses. If there are other reasons to need to get to your cash, Roth IRA distribution rules are more flexible than what applies to traditional IRAs and 401(k)s. The IRS allows tax- and penalty-free withdrawals of contributions from a Roth IRA at any time and for any reason.
6. The deadline to contribute for the 2016 tax year has already passed.
You have until April 18 (the tax filing deadline) to contribute to an IRA for the 2016 tax year. As long as you are writing checks you might as well start adding funds to your IRA for 2017. The earlier you contribute to an IRA the more time you give your money to compound and grow.
Dayana Yochim is a staff writer at NerdWallet, a personal finance website.