Individual retirement accounts (IRAs) let investors 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 similarly to qualified plans. Like most qualified plans, contributions may be deductible against earned income. For example, an investor earning $50,000 who contributes $4,000 to a traditional IRA is 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 the amount they earned. For example, a person earning $3,000 from a part-time job during the year can contribute a maximum of $3,000.
Investors may contribute each year up to the contribution limit. They can also make a contribution for a specific tax year up to the tax-filing deadline the following year (typically April 15). For example, an investor can contribute toward 2025’s limit until April 15, 2026. Contributions made between January 1, 2026 and April 15, 2026 must be specifically assigned* to 2025 or 2026.
*Assume an investor makes their first-ever IRA contribution on February 1, 2026. They must decide whether it counts 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. Despite the name, the accounts are separate - there is 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 provision is designed to help investors who contributed less earlier in their careers build retirement savings more quickly. 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 can access a qualified retirement plan through their work. For example, an investor working at a corporation that offers a 401(k) is covered by a qualified plan.
If an investor doesn’t have access to a qualified workplace plan like a 401(k), they can always deduct their traditional IRA contributions. If they do have access to a qualified workplace plan, deductibility depends on income: as income rises, the deduction is reduced and may be eliminated. You won’t need to know the specific income thresholds for the exam, but you may see questions testing the general concept.
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 often provides more investment choices. Many qualified plans limit the types of investments they allow. IRAs are only prohibited from short sales, margin, and some option strategies*.
*In particular, an investor cannot sell uncovered (naked) options due to the significant risk involved.
Roth IRAs are a newer retirement account created in the 1990s. Named after Senator William Roth, this type of IRA uses a “reverse” tax structure 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.
Although contributions aren’t deductible, there are contribution limits. 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.
To avoid taxes on Roth IRA distributions, the account owner must meet two requirements. First, the owner must be at least 59 ½ years old (otherwise, a 10% early withdrawal penalty is assessed). Second, the account must have been 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 1) of the first contribution.
*Investors who take distributions after age 59 1/2 but before meeting the five-year aging period owe ordinary income taxes on gains above basis, but they do not owe 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. Because qualified Roth IRA distributions aren’t taxable, the IRS doesn’t require distributions to begin at a certain age.
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 indefinitely.
Distribution rules depend on the type of beneficiary:
A spouse has added flexibility when inheriting IRA assets. A spousal beneficiary generally has these options:
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 under age 73, they are not required to take distributions. However, if they take a distribution before age 59 1/2, the 10% early withdrawal penalty may apply.
Claim the assets into an inherited IRA
If the spousal beneficiary is under age 59 1/2 and expects 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. The main option for non-spouse beneficiaries is the following, although the distribution method depends on the beneficiary type:
Claim the assets into an inherited IRA
This option works the same way as described 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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