IRA Contribution Limits
IRAs have been an important element to retirement planning for many. Whether it’s a traditional IRA or Roth IRA, they have helped investors benefit from tax advantages for retirement.
However, compared to a 401(k), IRAs have lower contribution limits. It’s important to adhere to the contribution limits, because if you don’t, you may face a 6% tax on both the excess contributions, as well as the investment earnings.
To avoid tax penalties, account holders should familiarise themselves with the IRA contribution limits for 2023 and apply the information to their retirement plan.
IRAs are powerful savings vehicles that bestow significant tax advantages to accountholders. As you work toward retirement, it can be beneficial to have a traditional IRA and a Roth IRA. This will enable you to maintain flexibility in taking income distributions in a tax-efficient manner during retirement, drawing down on the taxable traditional IRA in low-income years and drawing down on the tax-exempt Roth IRA in high-income years.
Thomas J. Brock, CFA®, CPAInvestment, Corporate Finance and Accounting ProfessionalThomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.
Roth IRA Contribution Limits in 2023
For the tax year 2023, the maximum contribution to a Roth IRA is $6,500 for those younger than 50 and $7,500 for those who are 50 or older.
These contribution limits have changed since last year. In 2022, it was $6,000 for those younger than 50 and $7,000 for those 50 or older.
The 2023 contribution limits also apply to spousal Roth IRAs. If a spouse decides to contribute to a Roth IRA for their partner — in addition to their own — the contributions to both Roth IRAs cannot exceed $13,000 if they are both younger than 50, $13,000 if only one is younger than 50, and $15,000 if they are both over age 50.
Traditional IRA Contribution Limits in 2023
The 2023 contribution limits for Roth IRAs also apply to traditional IRAs. Similarly, the same limits apply to traditional spousal IRAs as well.
If an investor has both traditional and Roth IRAs, the $6,500 and $7,500 limits apply to the total contribution of both accounts. Meaning, all the money contributed across both the traditional and Roth IRA cannot exceed $6,500 or $7,500.
If a single filer, a married couple filing jointly or a married couple filing separately have no retirement plans at work, they can contribute up to the $6,500 or $7,500 limits depending on their age.
What Does MAGI (Modified Adjusted Gross Income) Mean?
MAGI stands for Modified Adjusted Gross Income. It takes the AGI figure and adds back certain deductions.
Deductions Added Back to Determine Your MAGI
- Student loan interest
- Tuition and fees
- Qualified tuition expenses
- Excludable savings bond interest
- Foreign housing deduction
- Excluded employer-provided adoption benefits
- Half of any self-employment taxes
- IRA contributions and Social Security
- Losses from a publicly traded partnership
- Passive income or loss, etc.
You can only contribute to a Roth IRA if your MAGI is within the 2023 income threshold determined by the IRS. You can refer to this table by the IRS to find out whether your contributions to a Roth IRA are affected by your MAGI.
For traditional IRAs, the level of MAGI does not determine how much a person can contribute. So, there are no income limits that effect the contribution amount or exclude people from earning too much.
However, this benefit – the no-income limit – does not apply to traditional IRA holders who also have a 401(k) or some other employer-sponsored plan at work.
In the case where a traditional IRA is held in addition to an employer-sponsored plan, the following deduction limits apply:
- For those married and filing jointly and the traditional IRA holder is the one covered by an employer-sponsored plan — they can max out the deduction if MAGI is less than $116,000. They can make a partial deduction if MAGI is between $116,000 and $136,000. But they can’t make any deduction if MAGI exceeds $136,000.
- For those married and filing jointly where the traditional IRA holder is not covered by an employer-sponsored plan, but the spouse is — they can max out the deduction if MAGI is less than $218,000. They can make a partial deduction if MAGI is between $218,000 and $228,000. But they can’t make any deduction if MAGI exceeds $228,000.
- For single filers who are covered by an employer-sponsored plan — they can max out the deduction if MAGI is less than $73,000. They can make a partial deduction if MAGI is between $73,000 and $83,000. But they can’t make any deduction if MAGI exceeds $83,000.
- For those married and filing separately and either spouse is covered by an employer-sponsored plan — they cannot max out deductions at all. They can make a partial deduction if MAGI is less than $10,000. They can’t make any deduction if MAGI exceed $10,000.
IRA Contribution Limit Exceptions
The contribution limits for Roth and traditional IRAs do not apply in the case of rollovers, including backdoor Roth IRAs. Account holders can roll over any amount from one IRA to another without considering limits. Meaning, if an IRA has $50,000 worth of investments, the investor can move all of it to another IRA account without considering the $6,500 and $7,500 limits.
According to the IRS, qualified reservist repayments (QRR) also don’t have contribution limits. A QRR is the repayment of a qualified reservist distribution made from an IRA. Unlike normal distributions that attract an early withdrawal penalty, QRDs are free from penalties if it’s done before you turn 59 1/2.
Also, these distributions can be repaid to the IRA. And when they are repaid, the account holder can go beyond the $6,500 and $7,500 limits. For example, say Mr. Smith made a QRD of $20,000; he can return the $20,000 to the IRA (a QRR) without being guilty of making excess contributions.
What If I Accidentally Contribute Too Much?
Any contributions beyond the contribution limits that apply to an IRA holder are referred to as excess contributions.
According to the IRS, any extra contributions made into an IRA — traditional or Roth — will be subject to a 6% tax, as long as they remain in the IRA. So, if the money stays for six years, there will be a 6% tax for each of those six years.
Also, the earnings made on those contributions will also be subject to the same 6% tax for as long as they remain in the IRA.
The best way to avoid this is to pay attention to your contributions and familiarize yourself with the contribution limits that apply.
Fortunately, once an account holder has made the mistake, they can still correct it by withdrawing the excess contribution and earnings by the income tax return due date. If returns have already been filed, amended returns can be filed showing the effect of the withdrawal within the period of extension (October of the tax year).
But it’s important to note that if this withdrawal takes place before the account holder is 59 1/2, there will be a 10% tax for early withdrawal.
In that case, it may be better for the account holder to apply the excess contributions to the next tax year and pay the 6% tax rate.
Be sure to include your financial advisor in the operation of your IRA. This will help you avoid excess contributions and any other action that might go against IRS rules. It will also enable you to make the best decisions that will maximize the benefits you derive from your IRA.
