A traditional Individual Retirement Arrangement (IRA) allows earnings on your investments to accumulate without being taxed as income until withdrawal. With a few exceptions, you will incur a penalty if you withdraw money from a traditional IRA before the age of 59 1/2. Rules for withdrawals and tax deductions are different for a Roth IRA. The IRS has crafted regulations concerning the type of income that can be contributed and the timing and amounts of allowable contributions and withdrawals.
You are allowed to contribute up to $5,000 a year to a traditional or Roth IRA, as of 2010. If you are 50 or older, you are entitled to what is called a catch-up contribution of an additional $1,000 per year, which means you can put a total of $6,000 per year into your IRA. Even if you have more than one IRA, you cannot exceed the contribution limit for the year. For example, if you are under 50 and contribute $2,800 to one IRA, whether traditional or Roth, you can put no more than $2,200 into the other IRA for that tax year. Whether you can deduct your traditional IRA contributions on your tax returns depends on your filing status, your income, and whether your employer provides a retirement plan. You cannot deduct contributions to a Roth IRA.
You can only contribute earned income to an IRA, according to the IRS. Earned income is defined as wages, salaries, tips, commissions, alimony and military pay. You cannot put earnings from interest, dividends, pension or rental income into an IRA.
Age Limit on Contributions
Once you reach the age of 70 1/2, you cannot make any further contributions to your traditional IRA. This rule takes effect the first day of year in which you reach 70 1/2. For example, if you turned 70 in October 2009, you will achieve age 70 1/2 in April 2010. Consequently, you cannot make any traditional IRA contributions in 2010 or after. Roth IRA rules impose no age limits on contributions.
Age 59 1/2 Rule
Contributions withdrawn from a traditional IRA before you reach age 59 1/2 incur a 10 percent penalty in addition to being taxed as income. The major exceptions to this rule include withdrawals (up to $10,000 as of 2010) for the purchase of a first home, to fund higher education expenses and in the event of permanent disability and death, in which case your beneficiary can withdraw your IRA funds. You also can withdraw traditional IRA funds without penalty to cover the cost of health insurance premiums if you become unemployed and to pay excessive health care costs. Roth IRA rules allow you to withdraw contributions without tax or penalty before age 59 1/2, provided the account has been open for five years. However, withdrawing earnings from a Roth IRA before you reach 59 1/2 results in a 10 percent penalty, and the withdrawn amount is taxed as income. Similar exceptions exist for the Roth IRA as for the traditional IRA.