Clearing up retirement contribution limits

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Dear Dr. Don,
The contribution limits for retirement accounts are unclear to me. I participate in my employer-matched 401(k) plan and also have a Roth IRA that I max out every year. I’m wondering how these contribution limits affect me. For example, if I was to open another traditional or Roth IRA account and fund it, would I be penalized for overcontributing?
— Scott Saver

Dear Scott,
Yes, you would be penalized for overcontributing. You can have multiple accounts, but the combined IRA and Roth IRA contributions for a tax year can’t exceed the contribution limits for that year.

Here’s how the IRS puts it in Publication 590, Individual Retirement Accounts:

Roth IRAs and traditional IRAs. If contributions are made to both Roth IRAs and traditional IRAs established for your benefit, your contribution limit for Roth IRAs generally is the same as your limit would be if contributions were made only to Roth IRAs, but then reduced by all contributions for the year to all IRAs other than Roth IRAs. Employer contributions under a SEP or SIMPLE IRA plan do not affect this limit.

This means that your contribution limit is the lesser of:

  • $5,000 ($6,000 if you are age 50 or older) minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs, or
  • Your taxable compensation minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.

This limit may be increased to $8,000 if you participated in a 401(k) plan maintained by an employer who went into bankruptcy in an earlier year. For more information, see “Catch-up contributions in certain employer bankruptcies” in Publication 590.

However, if your modified adjusted gross income is above a certain amount, your contribution limit may be reduced, as explained later in Publication 590 under “Contribution limit reduced.”

If you’re married and your spouse doesn’t fund a Roth or traditional IRA, you would have the ability to contribute to a spousal IRA. The type and amount of spousal IRA account you can fund is influenced by income levels and filing status. A spousal traditional IRA may have to be funded with nondeductible contributions. See the “Spousal IRA Limit” section in IRS Publication 590 for more information on this type of IRA account.

The story “Retirement plan contribution limits,” from Bankrate’s 2011 Tax Guide, provides additional detail for the 2010 and 2011 tax years.

Join Bankrate’s personal finance expert Dr. Don and tax guru Kay Bell for a Retirement Reality chat at 2 p.m. EST, Monday, Jan. 31. They’ll be here live to tackle your toughest retirement questions. Mark your calendar and sign up for an event reminder today.

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