General Limit

• The IRS sets the normal limit for an IRA at $5,000 a year or your annual income, whichever is less. Annual income is defined as the amount of money in Box 2 of your W-2 form. The IRS considers wages, tips, commissions, self-employment money and alimony as income. Income from rents, pensions, interest and dividends are examples of nonearned income.
  
  

Exceptions

• An exception to the rule starts at age 50. The contribution limit for individuals age 50 and above is $6,000 a year or your income, whichever is less. Another exception occurs when you have been contributing to a retirement plan such as a 401k at a company that has gone bankrupt. In these circumstances, you can contribute up to $8,000 a year. If you are age 50 or older, you are still limited to $8,000 and do not continue to receive the $1,000 age exception.
  
  

Excess Contributions

• Excess contributions are deposits in your IRA that are more than your contribution limit. If you are age 40, for example, and you contribute $6,000 to your IRA, the amount above $5,000 is your excess contribution. In this situation, the extra $1,000 could be penalized or you could count the extra $1,000 toward a future year's contribution limit. In that future year, your contribution would be limited to $4,000 instead of $5,000. Excess contributions can be withdrawn before the tax filing deadline with no penalty, but you are charged income taxes on the amount contributed in a deferred account.
  
  

Conversion Contributions

• When rolling over an IRA into another retirement account you are allowed a one-time conversion contribution. This means the entire amount can be moved from one IRA and contributed to another with no excess contribution penalties. If you are rolling over into a Roth IRA or other nondeductible savings vehicle, you will be responsible for income taxes on the amount rolled over. If you are rolling over a traditional IRA to a Roth IRA, you no longer have limits on income or contributions on the conversion to the Roth. For 2010, the income taxes owed on the traditional IRA can be split over 2010 and 2011, giving an individual extra incentive to roll over in 2010.
  
  

Penalties

• Watch for penalties. Excess contributions and the returns on their investment can be taxed every year they stay in the retirement account. Excess contributions and their returns are taxed at 6 percent. You can determine the amount you will be taxed by multiplying the excess contribution by .06. The amount earned on the excess contribution can also be multiplied by .06 to determine the amount owed on the investment returns.