Individual retirement accounts (IRAs) allow investors to save for retirement outside of employer-sponsored plans. This chapter covers two types:
Traditional IRAs are non-qualified retirement plans because they aren’t workplace-sponsored, even though they work a lot like qualified plans. Like most qualified plans, contributions may be deductible against earned income.
For example, if an investor earns $50,000 and contributes $4,000 to a traditional IRA, they’re taxed on $46,000 of earned income. Distributions are typically fully taxable as ordinary income.
The contribution limit for IRAs in 2026 is the lesser of $7,500 or the amount of earned income during the year.
To contribute, investors must have earned income. If an investor has no reportable earned income, they can’t make an IRA contribution. For example, a person who is unemployed throughout the year is ineligible to contribute. If an investor earns less than the contribution limit, they can only contribute up to what they earned. For example, a person earning $3,000 from a part-time job throughout the year can contribute a maximum of $3,000 to their IRA.
Investors may make IRA contributions each year up to the contribution limit. They may also contribute for a specific tax year up to the tax-filing deadline the following year (typically April 15th). For example, an investor can contribute toward 2025’s contribution limit until April 15th, 2026.
Contributions made between January 1st, 2026 and April 15th, 2026 must be specifically assigned* to 2025 or 2026.
*Assume an investor makes their first-ever IRA contribution on February 1st, 2026. They must decide whether the contribution will count toward 2025’s $7,000 limit or 2026’s $7,500 limit (contribution limits increased by $500 in 2026). In most circumstances, it’s better to contribute to the previous year’s limit until it is reached.
As discussed above, only individuals with earned income may contribute to IRAs. However, the IRS allows a working spouse to contribute to a non-working spouse’s IRA.
For example, assume Jane works and is married to John, who is unemployed. Even though John has no reportable income, Jane can contribute to John’s IRA on his behalf. This is called a spousal IRA contribution.
Even with this rule, the accounts are still separate - there’s no such thing as a joint IRA.
Investors age 50 or older are eligible for a catch-up provision, which allows an additional contribution of $1,100 per year. This lets investors who missed contributions earlier in life build retirement savings faster.
In 2026, a person age 50 or older may contribute up to $8,600 ($7,500 + $1,100 catch-up).
Traditional IRA contributions are not always deductible. Three situations determine the tax status of a contribution:
Investor is not covered by a qualified workplace plan
Investor is covered by a qualified workplace plan and low income
Investor is covered by a qualified workplace plan and high income
Covered by a qualified workplace plan means the investor has access to a qualified retirement plan through work. For example, an investor who can contribute to a 401(k) through their employer is covered by a qualified plan.
If an investor has no access to a qualified workplace plan like a 401(k), they can always deduct their contributions. If they do have access to a qualified workplace plan, deductibility depends on income: generally, the higher the income, the less likely the contribution is deductible. You won’t need to know the specific income thresholds for the exam, but you may see questions testing the general idea.
If an investor makes non-deductible contributions to a traditional IRA, they’re taxed only on the growth when a distribution (withdrawal) is taken. The basis (the amount contributed) is returned tax-free upon withdrawal.
When retiring or leaving a job with a qualified plan, many investors roll their retirement plan assets into IRAs. A rollover from one retirement plan to another is not a tax-reportable event (no taxes due at the time of the rollover). Rolling assets into an IRA keeps them tax-sheltered and can provide more investment choices.
Most qualified plans limit the types of investments they allow. IRAs are only prohibited from short sales*, margin, and some option strategies** with unlimited risk potential.
*A short sale involves the sale of borrowed securities, typically as a means of betting against that security.
**In particular, an investor cannot sell uncovered (naked) options due to the significant amount of risk involved.
Roth IRAs are a newer retirement account created in the 1990s. Named after Senator William Roth, this type of IRA has a “reverse” tax treatment compared with many retirement plans.
Contributions are made after-tax, which means they are not deductible. Roth IRA assets grow tax-sheltered and can be withdrawn in retirement tax-free if specific requirements are met.
Even though contributions aren’t deductible, contribution limits still apply. The same traditional IRA contribution limit of $7,500 per year applies to Roth IRAs.
Also, the contribution limit applies to both IRA types combined. If an investor contributes $3,000 to a traditional IRA, they may contribute only $4,500 to a Roth IRA. If the account owner is age 50 or older, they may contribute an additional $1,100.
Not all investors are eligible to contribute to Roth IRAs. In particular, investors with high incomes can’t contribute. You won’t need to know the specific numbers for the exam, but they’re included below for context.
Roth IRA owners must meet two requirements to avoid taxes on distributions.
First, the account owner must be at least 59 ½ years old. Otherwise, a 10% early withdrawal penalty is assessed.
Second, the account must be open for at least five years. For example, an investor who opens their first Roth IRA at age 60 must wait until age 65 for tax-free withdrawals.
The five-year aging period* for Roth IRAs starts on the first day of the tax year (typically January 1st) of the first contribution.
*Investors taking distributions above age 59 1/2 but who haven’t reached the five-year aging period are subject to ordinary income taxes on the gains above basis, but not the 10% penalty. For example, assume a 60-year-old opens their first Roth IRA and contributes $5,000. Two years later the account is worth $8,000, and the investor requests a full withdrawal. They will pay ordinary income taxes on the $3,000 of growth, but no additional 10% penalty.
We learned earlier that most retirement plans are subject to required minimum distributions (RMDs) when the account owner turns 73. Roth IRAs are not subject to RMDs. Since taxes aren’t assessed when distributions occur, the IRS doesn’t require Roth IRA owners to take distributions.
Many Americans die (hopefully at an old age) with balances in their IRAs. When this happens, beneficiaries (the people who inherit the accounts) must follow specific distribution rules. The Internal Revenue Service (IRS) does not allow assets to remain in tax-sheltered accounts forever.
Distribution rules fall into two categories based on the beneficiary:
A spousal beneficiary has added flexibility when inheriting IRA assets from a spouse. The main options are:
Claim the IRA as their own
This option allows the spousal beneficiary to roll the inherited assets into their own IRA. If the spousal beneficiary is below age 73, they are not required to take distributions. However, they may face the 10% early withdrawal penalty if they take a distribution before age 59 1/2.
Claim the assets into an inherited IRA
If the spousal beneficiary is below age 59 1/2 and plans to take a distribution, placing the assets into an inherited IRA is often the better choice. The tradeoff is that inherited IRAs require distributions. Specifically, the spousal beneficiary can elect to take annual RMDs or distribute all assets within 10 years.
There are two types of non-spouse beneficiaries: eligible designated beneficiaries and designated beneficiaries.
An eligible designated beneficiary is a minor child of the decedent (deceased IRA owner), a permanently disabled person, a chronically ill person, or a person not more than 10 years younger than the decedent. A designated beneficiary is anyone who does not meet one of those criteria.
This is the primary option for non-spouse beneficiaries, although distribution methods may vary depending on the type of beneficiary:
Claim the assets into an inherited IRA
This option is the same as we discussed above for spousal beneficiaries. Distributions are not subject to the 10% early withdrawal penalty, but distributions are required. Eligible designated beneficiaries can elect to take annual RMDs over their lifetime. Otherwise, either type of non-spouse beneficiary can elect to distribute all assets within 10 years.
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