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Rules for IRA Owners

IRAs are the most efficient way of financially preparing for retirement. These individual retirement accounts offer unique tax benefits while allowing you to actively invest your money and grow your retirement savings. With CARL's self-directed IRAs, you can even invest in alternative investment opportunities such as CARL's quantitative hedge funds, opening up amazing chances with great returns and built-in risk controls. However, if you're planning your retirement with an individual retirement account, there are rules you need to keep in mind.

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What Are These Rules For?

The main concept behind traditional and Roth IRAs is: The U.S. government provides you with a way to save money for retirement more efficiently by giving you tax benefits – but they want to make sure you're not using your tax-advantaged account for anything else besides retirement saving. Every rule associated with this account type can be traced directly to this idea. For example, limits on contributions are in place to prevent powerful investors from using IRAs for regular investing, and required minimum distributions (RMDs) exist because the IRS wants to make sure you actually take advantage of the money in your account after age 72.

If you're unclear about the rules, keeping in mind why these rules exist in the first place might help you to interpret their intent. Be aware that the rules are subject to change as new laws may be passed that change and adapt them. For example, the age at which you are required to take required minimum distributions was changed from 70.5 to 72 by the SECURE Act of 2019. Thus, the information presented here may be outdated due to new legislation. So make sure you consult a financial and tax advisor before making any decisions pertaining to your retirement plan.

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How to Qualify for an Individual Retirement Account

There are various types of individual retirement accounts, all of which feature different rules, especially in terms of how you qualify for them. SEP IRAs and SIMPLE IRAs are both employer-sponsored to one degree or another, but the rules that govern them are mostly identical to traditional IRAs.

Income Limits for Opening IRAs

The first thing you need to know before setting up your retirement account is: To contribute to an IRA, you must have income. For the purposes of IRA contributions, the IRS defines income as "all the taxable income and wages you get from working for someone else, yourself or from a business or farm you own". This means you can't contribute income in a year in which you haven’t had income – and brokers or financial institutions which offer IRAs may not be willing to open such an account for you if you can't prove that you have a regular income.

What's important to note here is that IRA rules do not prevent you from owning such a retirement account or investing the money which is already in the IRA if you no longer have an income. So if you set up an IRA when you had regular income, you can still use it in a later year when you didn't have an income. You just can't contribute new money to the account that year, though investments made with money in the account may still generate earnings.

Also, keep in mind that Roth IRAs have upper-income limits, which means you won't be able to contribute to a Roth IRA if your income for the year exceeds a specific amount. Like with traditional IRAs, this may cause brokers and financial institutions to deny your application to open a Roth IRA, as you won't be able to contribute until your modified adjusted gross income (MAGI) decreases.

When Can You Start Investing in an IRA?

For both traditional IRAs and Roth IRAs, there is no upper or lower limit to how old you have to be to contribute to an IRA. Combined with the annual contribution limits, this makes it a great idea to open an individual retirement account as early as possible. You still need to have income, though, so a minor child usually won't be able to open an account – or at the very least contribute to it – until they have their first job. 

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Depositing and Withdrawing

Most of the rules surrounding traditional IRAs and Roth IRA are about depositing money (which the IRS calls "contributions") and withdrawing money ("distributions") as the account owner.

Traditional IRA Contributions

There are three important rules to keep in mind when contributing to a traditional individual retirement account:

  • You can only contribute to a traditional account if you have taxable income in the same year.
  • Contributions are tax-deferred, which means the money you contribute is tax-free until you withdraw it.
  • There is an annual limit for tax-free contributions.

This means the IRS limits how much money you can contribute to your own IRA. As of 2022, this limit stands at $6,000 (or $7,000 if you're 50 or older). However, you may not contribute more than your taxable income per year. So if you made $5,000, you wouldn't be allowed to contribute the full $6,000. On the flip side, any money you contribute above the limit will be subject to income tax in the current tax year. 

Traditional IRA Distributions

Traditional individual retirement accounts feature rules which both regulate how you're allowed to withdraw money and rules which require you to withdraw under certain circumstances:

  • Withdrawals incur income tax according to your tax bracket.
  • If you're under 59.5, withdrawals incur a 10% penalty tax.
  • If you're over age 72, you have to take required minimum distributions (RMDs).

In other words: You can withdraw money from your traditional IRA at any time, but if you're too young, you'll have to pay a penalty, and if you've reached 72 years of age, you are now required to withdraw money from your account annually. You need to make your first withdrawal before 1 April, the year after you've turned 72, and then at the end of every year thereafter. So if you turned 72 in 2030, you now have to take your first required minimum distribution for 2030 no later than the last day of March 2031. Thereafter, you need to withdraw annually no later than December 31st, starting with the first year after you've turned 72 – yes, this means that if you took your first withdrawal in March 2031, you'd need to withdraw again by December 31st, 2031.

How much money you're required to withdraw due to RMDs changes from year to year, as the exact value depends on the "distribution period", which is based on life expectancy and changes according to your age. You can find the currently applicable "Uniform Lifetime Table" matching your age with your distribution period on the IRS website. Once you have your distribution period for your age, you can divide your traditional IRA's year-end value in dollars by the distribution period which applies to you. The resulting dollar value is the amount you need to withdraw as a required minimum distribution.

Roth IRA Contributions

The rules for contributing to a Roth IRA differ notably from those for a traditional IRA:

  • Contributions to a Roth IRA count towards your taxable income that year, so they are not tax-free.
  • The annual upper contribution limit is the same as for traditional IRAs.
  • If your MAGI is high enough, this can cause your limit for contributions to go down or even reach $0 in a year.

The most complex aspect of contributing to a Roth IRA is the contribution limit. Like with traditional accounts, the annual limit is $6,000 (or $7,000 if you're over 50). But as your modified adjusted gross income increases, your limit will shrink. As of 2022, you can contribute the full amount per year if your MAGI is less than $125,000 (for singles) or $198,000 (for married couples filing jointly). If you make more than that, your contribution limit will decrease over several stages until it reaches $0 once you make $140,000 (single) or $208,000 (married, joint filing). In other words: If you start making more money than you expected, you may want to look into opening a traditional IRA in addition to keeping your Roth IRA.

Roth IRA Distributions

Once you reach retirement age, Roth IRAs can be more convenient than traditional IRAs as they have fewer restrictions when withdrawing:

  • You can withdraw the money you contributed whenever you want, with no income tax added.
  • Withdrawing earnings derived from investments will incur income tax unless you're 59.5 years old (or older) and the money has been in your account for at least five years (the "5-year rule").
  • You don't have to take required minimum distributions.

This means you're effectively free to withdraw your money whenever you want. You'll only have to pay taxes on investment earnings – and only under specific circumstances. If you're a savvy investor, this means that you may potentially turn your small contributions (owed to the income and contribution limits) into significant wealth, which is entirely tax-free under the circumstances outlined above.

A Special Case: Additional Rules for Traditional IRA Owners With Workplace Retirement Plans

If you're covered by an employer-sponsored workplace retirement fund like a 401(k), or you're married, and either you or your spouse are covered, you have to keep in mind a special rule for traditional IRAs. Normally, any money you contribute up to your limit in a traditional account will be deducted from your taxable income that year. However, if you or your spouse own an employer-sponsored retirement plan, the money you put into your IRA may not be fully deductible. As of 2022, this means:

  • Single + own workplace plan + MAGI over $68,000 but under $78,000 = partially deductible
  • Single + own workplace plan + MAGI over $78,000 = non-deductible
  • Married (filing jointly) + own workplace plan + MAGI over $109,000 but under $125,000 = partially deductible
  • Married (filing jointly) + own workplace plan + MAGI over $129,000 = non-deductible
  • Married (filing jointly) + spouse in workplace plan + MAGI over $204,000 but under $214,000 = partially deductible
  • Married (filing jointly) + spouse in workplace plan + MAGI over $214,000 = non-deductible
  • Married (filing separately) + own/spouse in workplace plan + MAGI under $10,000 = partially deductible
  • Married (filing separately) + own/spouse in workplace plan + MAGI over $10,000 = non-deductible

What Are the Rules on an Inherited IRA?

If the IRA owner is deceased, inheriting an IRA requires you to follow an entirely new set of rules, as the government hopes you will either take over the IRA or liquidate the assets in the account within 10 years ("10-years rule" introduced by the SECURE Act). If you've inherited your account, CARL strongly recommends you contact a tax advisor who can give you explicit advice on what you're now legally required to do. All we can offer here is a short overview of the most important rules:

  • Tax-wise, an inherited IRA follows the same rules it followed during the original owner's lifetime. Also, if the account required the original owner to take RMDs, you may have to do the same.
  • If you're a beneficiary of the IRA (not a spouse who decided to become the new account owner), you are required to withdraw all of the money in the account by December 31st, 10 years after the IRA owner's death.
  • You may legally count as the spouse of the deceased or a non-spouse beneficiary such as an eligible designated beneficiary (minor children of the deceased, chronically ill or handicapped IRA beneficiary or beneficiary that is no more than 10 years younger than the deceased) or a designated beneficiary (everyone else). Your options depend on which type of beneficiary you are.

Spouses get to either become the new IRA owner, roll over the account into their own account, keep acting as a beneficiary within the 10-year rule, or withdraw all of the money as a lump sum (taxes and early withdrawal penalties may apply). If you're an eligible designated beneficiary, you have the same options, with the exception of becoming the new account holder. If you're a designated beneficiary, you can only choose to withdraw the money from the account, either as a lump sum or in several steps over the next 10 years.

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Self-Directed IRAs: Take Advantage of Your Options With CARL

Whether you decide on a traditional or a Roth IRA determines which set of rules you will have to follow. However, both account types also limit your options regarding what you can invest your money in. In both cases, you're effectively limited to traditional investment options such as stocks and bonds, which may not give you the returns you want. Instead, you may want to look into opening a self-directed IRA (SDIRA), which can be either a traditional or a Roth IRA. SDIRAs follow the same rules, but they also allow you to invest in alternative investment opportunities such as private equity.

With a self-directed IRA, you can take full advantage of CARL's quantitative hedge fund strategies, which offer 15%+ targeted returns and built-in risk controls. This gives your retirement plan the power to grow your wealth faster than a standard IRA would be able to – and thanks to hedging strategies, your risk level is notably lower than usual for alternative investment options. Set up your SDIRA with CARL or use our quants as part of your IRA investment portfolio – your future self with thank you.

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