What Is a Contributory IRA? Tax Benefits and Investment Options

A contributory IRA is an individual retirement account arrangement where an employee deposits funds directly from their salary to a pension.

The employer is encouraged to match the contribution to an individual retirement account. Also, many employers boost employees’ individual retirement accounts (IRA) by depositing additional contributions.

The employee gets to choose where they will be invested from various options offered by their IRA plan provider. Like all other IRA contribution plans, there is no guaranteed amount upon retirement.

Instead, the account balance will be a net of the contributions, investment gains, and losses.

One should be careful when selecting an IRA or any other retirement plan. It could have a huge effect on the amount of your retirement savings.

Contribution Limits

Due to tax benefits for an IRA owner, an IRA contribution can be used to reduce income tax.

The federal government sets a maximum amount that can be contributed to an IRA account based on the annual cost of living.

In the 2022 tax year, the annual maximum you can contribute to an IRA account is $6,000. However, if you are 50 years old and above, you are eligible for an extra annual retirement plan catch-up amount capped at $1,000. This will bring your total permissible IRA contribution to $7,000.

In 2023 the maximum contributory amounts to an IRA is $6,500 or, if you are over 50 years old, $7,500.

Your deductible contribution cannot be above your taxable compensation. The maximum you can contribute is 100% of your computable income. Any other income connected to you is not permissible.

If your taxable or gross income is below the stipulated limits, it becomes your maximum contribution limit.

If you have multiple IRA accounts, all their total contribution should be within the required limits.

IRAs have no legal lower limit, and contributors decide the amount they are comfortable with for each open account.

However, some IRAs have minimum balances set internally as organizational policies.

Spousal IRA

This feature of contributory IRAs enables married couples who file joint returns to increase their contributions. This comes in handy if one party is not getting income or is below the desired combined amount.

The IRA will not be joint, however. Each individual has an account, but the better compensated can make deposits into their spouse’s account up to the permissible individual limit.

It might enable the couple to save more for retirement than would have been possible if they filed returns separately.

The total contributions for both accounts should not exceed the taxable earnings from their joint returns.

Eligibility to Participate

There are basic requirements that must be met every tax year to be eligible to contribute to an IRA, regardless of whether they were previously contributing.

Income Required For IRA Contributions

You are prohibited from contributing to an IRA if you did not have taxable income for the year in question. 

A spouse can contribute to your IRA if you file joint returns up to your current income limit, provided your total contributions don’t surpass your taxable income limit as declared in the joint returns.

No minimum or maximum age for IRA contributions

From 2020, the age limit for making IRA contributions was scrapped. You can keep saving for retirement as long as you work and earn an income.

Can A Contributory IRA Be Combined with Other Retirement Plans?

You can have a contributory IRA even when your business or employer has another retirement plan for you, whether they are contributory or defined benefit plans.

It is even legal to have more than one contributory IRA. So, for example, you can have a traditional IRA and a Roth IRA to mix up the tax benefits.

Tax Benefits of Contributory IRAs

ira tax benefits

IRAs are intentionally set up with tax advantages to encourage the contributor to leave the funds untouched until retirement. As a result, they provide significant tax relief as you deduct all your IRA contributions from your federal income tax returns.

Tax payments on contributions are deferred until distribution, meaning tax is not deducted at the point of contribution and will only be applied when you withdraw the funds.

This enables you to maximize the value of your IRA in different ways:

  • Profits and capital gains without a tax deduction have compound growth, which exponentially increases the value of your retirement account
  • The tax applied when you withdraw the funds will be subject to your tax bracket. This is likely lower than your current bracket after retirement because your compensation will significantly reduce.
    As a result, the tax due will be less than when you contribute (unless there is a radical change in tax policy between contribution and withdrawal).

Are Investment Options Available for Contributory IRAs?

Institutions that provide IRAs include investment companies, credit unions, banks, mutual funds, and online brokers.

These experienced investors are bound by a fiduciary responsibility to ensure you get a reasonable range of options for the best investment deals.

The Employee Retirement Income Security Act (ERISA) obliges institutions to act in the best interests of the participants.

Participants can select single-fund options if they are not into complicated trades and aim for average results with minimal risks.

You can also pick from individual securities like bonds, stocks, exchange-traded funds (ETFs), or certificates of deposits (CDs) if you are more hands-on.

The third option is to hedge your retirement savings by combining investment approaches in different ratios depending on what you feel is working over the years.

The best contributory IRAs have a diverse menu of investment options with accessible educational resources to help you settle on the right investment combination for your future.

They should also fit within your budget in all features, including whether they have minimum deposits and if the threshold is affordable, if there are any commissions for the trades they do on your behalf, and whether their projected returns make sense considering the time value of money and costs incurred.

Related Resources: