IRA Rules in 2020 and 2021
We've covered the specific rules for each type of IRA elsewhere on this website, but we've never put all of them together in one place. In this article, we are going to provide a summary of these general IRA rules; this information will apply to eligibility, contributions, as well as withdrawals.
SIMPLE, Traditional, and Roth IRA Rules
We've decided on the format below because there are three types of Individual Retirement Accounts that taxpayers may be able to fund: Traditional, Roth, or SIMPLE IRAs. The IRS has established slightly different guidelines for each of these retirement offerings, and this article will help to explain some of the differences. If anyone needs more information, then click on one of the article links appearing in the resources box.
When we talk about IRA eligibility, we're really talking about who qualifies to make a contribution to an IRA. Most of the qualification rules are straightforward, and later on we'll discuss the answer to the question: How much can I contribute to an IRA?
In general, there are two eligibility rules that apply to Traditional IRAs. To participate, the taxpayer must be under age 70 1/2 at the end of the calendar year. The second states there must be some form of compensation to contribute to a Traditional IRA. Compensation can take the form of wages, salaries, bonuses, and commissions.
The eligibility, or qualifying rules, for a Roth IRA are less stringent than those of a Traditional IRA. To contribute to a Roth, there needs to be some form of compensation. There is no age limit or restriction for a Roth IRA.
To participate in a SIMPLE IRA, an employer must first offer the plan to its employees. The employer must have 100 or less employees that received $5,000 or more in compensation in the prior year. The employer cannot offer another qualified plan, such as a 401(k) plan. A SIMPLE IRA is a retirement solution for small businesses.
There is only one rule that applies to employees wishing to participate in their employer's SIMPLE IRA plan. They must have received at least $5,000 in compensation in the past two years, and they are expected to be paid at least $5,000 in the current year.
IRA Contribution Limits
The contribution limits appearing in this section help to answer the question: What is the maximum amount that can be contributed to an IRA? This does not necessarily mean that an individual can contribute this much money each year. Later on, we're going to discuss the income limits for IRAs.
The IRS has spelled out two sets of rules when it comes to the maximum contributions that can be made to a Traditional IRA. The first is the "standard" contribution limit. In 2020 and 2021, the standard contribution limit for a Traditional IRA is $6,000.In addition to the standard contribution, there is also a catch-up limit. Anyone that has reached age 50 or older in the calendar year is eligible for an additional catch-up contribution of $1,000 in 2020 and 2021. This means the total contribution in the years 2020 and 2021 cannot exceed $6,000 + $1,000, or $7,000.
In the years 2022 and beyond, these limits will be increased with an index of inflation.
Note: Updated contribution limits are generally available in mid to late October.
The maximum contribution limit for Roth IRAs is exactly the same as those for Traditional IRAs. In 2020 and 2021, the standard contribution maximum to a Roth IRA is $6,000.
Anyone reaching age 50 or older in a calendar year is entitled to take a catch up contribution. In the years 2020 and 2021, the catch up limit is $1,000. Combining the standard and catch up limits, participants can contribute up to $6,000 + $1,000, or $7,000.
Employees participating in a SIMPLE IRA plan can defer up to $13,500 in 2020 and 2021. Catch-up contributions for those 50 and older are $3,000 in 2020 and 2021. The standard deferral limits are expected to grow with the cost of living, and will apply to the 2022 values.
For more information on this topic, take a look at our detailed article on IRA Contribution Limits.
IRA Income Limit and Tax Deductibility
This is where the IRS rules for each IRA type start to get complex. With all three types of IRAs there are income limits for contributions. If anyone exceeds these income limits, which is based on their modified adjusted gross income or MAGI, they are not eligible to participate, or their eligibility to make a full contribution is phased-out.
In fact, there are even phase-out limits that apply just to the tax deductibility of a Traditional IRA. At this point, it is best to direct readers to more detailed articles that discuss eligibility, contributions, and income limits:
- Traditional IRA: detailed information and tables outlining income limits, deductibility, and phase-out information for each IRS tax-filing status.
- Roth IRA Rules: in addition to the above information, this article also discusses transfer and IRA distribution rules.
- SIMPLE IRA: besides the eligibility and contribution guidelines already discussed, SIMPLE IRAs need to address portability of the account. Just like a 401(k) plan, there are processes the IRS has spelled-out concerning SIMPLE IRA rollovers.
IRA Distributions / Withdrawals
Generally, investors and retirement planners use the terms withdrawals and distributions interchangeably. Regardless of the name, what we are going to discuss in the following sections are the rules by which it's possible to take money out of an IRA, as well as the possible tax penalties that apply if someone doesn't follow these guidelines.
With a Traditional IRA, we have what is sometimes refer to as the age 59 1/2 rule. This rule means that accountholders have to wait until they're age 59 1/2 before they can make a withdrawal from their IRA account without incurring a 10% additional tax penalty.
Traditional IRAs also have minimum distribution (MDR) rules that begin starting at age 70 1/2. The concept behind minimum required distributions, or MDRs, is quite simple. By using a life expectancy table, it's possible to calculate how much to withdraw from an account each year such that the balance in the IRA account would be zero when someone reaches their life expectancy age.
Accountholders can start to make what is called a qualified distribution after the 5th taxable year period beginning with the first year for which a contribution was made to a Roth IRA. They also need to reach age 59 1/2 to make a qualified distribution. There are exceptions to this rule. For example, accountholders can also make a withdrawal if they become disabled, or plan to use the money as a first time home buyer.
Roth IRAs are not subject to the minimum required distribution rule.
In general, SIMPLE IRAs follow the same exact withdrawal rules that apply to Traditional IRAs, including exceptions. But there is also what is called the "2-year period" that is unique to SIMPLE IRAs.
The 2-year period begins on the date on which the employee first participated in any SIMPLE IRA plan maintained by their employer. Technically, this is the first day on which a contribution is made by the employer and deposited into an employee's SIMPLE IRA fund.
If an employee takes an early distribution within this 2-year period, the additional tax penalty is raised from 10% to 25%. However, if one of the exceptions mentioned earlier applies to these early withdrawals, then the 25% tax penalty is not imposed.
For more detailed information on this topic, see our detailed article entitled IRA Withdrawals.
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