Funding an IRA: Contribution Rules and Methods

An Individual Retirement Arrangement (IRA) is a personal savings plan with tax advantages, separate from employer-sponsored plans like a 401(k). The government provides these tax benefits to encourage retirement savings. Depending on the type of IRA, you may receive an immediate tax deduction on contributions or tax-free withdrawals in retirement. This structure allows investments to grow and compound without being taxed annually on interest, dividends, or capital gains.

IRA Contribution Rules and Deadlines

The Internal Revenue Service (IRS) sets annual limits on IRA contributions. For the 2024 and 2025 tax years, an individual can contribute up to $7,000. This limit is the total for all your Traditional and Roth IRAs combined, not a separate limit for each account.

Individuals age 50 or older can make an additional “catch-up” contribution of $1,000. This provision helps those nearing retirement bolster their savings. This brings the total potential contribution to $8,000 for 2024 and 2025 for this age group.

A requirement for making an IRA contribution is having sufficient earned income. The IRS defines earned income as compensation from working, such as wages, salaries, tips, and bonuses, as well as net earnings from self-employment. Income that does not qualify includes interest, dividends, and pension or annuity income. Your total contribution for the year cannot exceed your earned income.

The deadline for making IRA contributions is the federal income tax filing deadline, which is April 15. This deadline does not include filing extensions. For example, contributions for the 2024 tax year can be made until April 15, 2025. This allows for a lump-sum contribution for the prior year up until the tax filing date.

Deciding Between a Traditional or Roth IRA

Choosing between a Traditional and a Roth IRA depends on how you want your contributions and withdrawals to be taxed. A Traditional IRA may offer an upfront tax deduction. Depending on your income and coverage by a workplace retirement plan, contributions may be tax-deductible, lowering your taxable income for the year.

Deductibility for a Traditional IRA is limited by income if you or your spouse are covered by a workplace plan. For 2025, the deduction for a single person with a workplace plan phases out with a modified adjusted gross income (MAGI) between $79,000 and $89,000. For married couples filing jointly where the contributor is covered, the range is $126,000 to $146,000. If only your spouse is covered, the phase-out range is $236,000 to $246,000. All withdrawals from a Traditional IRA in retirement are taxed as ordinary income.

A Roth IRA offers no upfront tax deduction, as contributions are made with after-tax dollars. The main advantage is that qualified distributions in retirement are completely tax-free. This tax-free status applies to both your original contributions and all investment earnings.

Eligibility to contribute to a Roth IRA is also based on your MAGI. For 2025, a single filer’s ability to contribute phases out with a MAGI between $150,000 and $165,000. For married couples filing jointly, the phase-out range is $236,000 to $246,000. You cannot make direct contributions if your income exceeds these limits.

Methods for Moving Money into an IRA

You can fund your IRA through several methods. A straightforward approach is making direct contributions from your personal savings. This is done through an electronic funds transfer (EFT) from a linked checking or savings account, which can be set up as a one-time or recurring payment. Many financial institutions also accept physical checks.

Another method is a rollover from an employer-sponsored plan like a 401(k), often done after leaving a job. A direct rollover is a seamless way to do this, where funds are transferred from the old plan administrator to the new IRA custodian. This process avoids tax withholding and potential penalties.

In an indirect rollover, the plan administrator sends you a check, minus a mandatory 20% federal tax withholding. You have 60 days to deposit the full amount, including the withheld portion, into your IRA. Failing to meet the 60-day deadline may result in the distribution being treated as a taxable event, possibly with a 10% early withdrawal penalty if you are under age 59½.

You can also move funds between similar IRAs using a trustee-to-trustee transfer. In this process, the financial institution holding the existing IRA sends the money directly to the new IRA custodian. This is common for consolidating accounts or changing providers and is not a taxable event. It is not subject to the 60-day limit or the one-rollover-per-year rule.

Correcting an Excess Contribution

Contributing more than the annual IRS limit results in an excess contribution. These are subject to a 6% excise tax for each year they remain in the account. This tax is calculated on Form 5329 and applies annually until the excess is corrected.

To avoid the 6% penalty, you must withdraw the excess contribution before the tax filing deadline, including extensions, for the year the contribution was made. For instance, if you over-contributed for the 2024 tax year, you have until October 15, 2025, to correct the error if you file a tax extension. This corrective action prevents the excise tax from being applied for that year.

The corrective process requires withdrawing both the excess contribution and any net income it generated. Your IRA custodian can help calculate the earnings or losses associated with the overage.

The tax treatment of the withdrawal is specific. The returned excess contribution itself is not taxed. However, the withdrawn earnings are considered taxable income for the year the excess contribution was made.