Are IRA Contributions Based on Gross Earned or Net?

Congress created the traditional IRA in 1974 to provide working Americans with incentives to save for retirement. The Roth IRA came into being three years later. Because IRAs offer tax advantages, a web of restrictions administered by the Internal Revenue Service govern the accounts. The rules regarding contributions are relatively straightforward.

Earned Income

IRS rules demand that IRA accounts of any type be funded only with earned income. In addition to wages, earned income for IRA contribution purposes includes salaries and commissions, tips, alimony, and taxable military pay. Rental and investment income does not qualify.

Gross vs. Net Income

The IRS considers gross, as opposed to net, income when it comes to IRA contribution eligibility. Given that the definition of earned income includes commission and tip income, and given that individual tax exemption and deduction options vary so widely, the agency would be hard-pressed to use net income as a benchmark.

Contribution Limits

The IRS limits how much you can place in an IRA in a single tax year. As of 2012, the limit was $5,000 for account owners who are not yet 50 years old. For all others, the limit was $6,000; the extra $1,000 is termed a "catch-up contribution," giving workers a savings boost as they get closer to retirement age. If you contribute more than the maximum in a given year, the IRS applies an excise tax of 6 percent to the overage.

Maximizing IRA Advantages

Because of the limits, financial professionals advise that you open and fund an IRA as soon as you begin earning income. Even if there are years in which you gross less than the contribution limit -- or earn nothing at all -- your past contributions can be earning tax-deferred or tax-free returns. In addition, it is money-smart to contribute the maximum each year that you gross at least $5,000, or $6,000 for those 50 and older.