After laying out some fundamental rules about deductibility of Traditional IRA (TIRA) contributions in my previous article, the following are additional basic points about TIRA contribution deductibility.
These questions address how traditional IRA (TIRA) rules apply in real-life situations. The corresponding answers are intended to illuminate those of you who have such questions.
A. Maybe you can. Because you do not have income or a retirement plan, you would fall under the “spousal IRA” rules. Your husband’s TIRA deduction phase-out begins at $99,000 and his ability to deduct any of his TIRA contribution is completely phased out at an Adjusted Gross Income (AGI) of $119,000 for 2017. But as a non-employed spouse, the “spousal IRA” phase-out begins at an AGI of $186,000 and is completely phased out by an AGI of $196,000. But, even if you cannot deduct your TIRA contributions, you can still make the non-deductible contribution to the TIRA regardless of your household AGI.
A. If you can, you should make your annual contributions equally spaced during the year and regularly invest these to be able to “dollar cost average” into your IRA investments. You will not take the deduction on your form 1040 until you actually file your tax return, not when you make the contributions during the year. Thus, if you are over the AGI limit, you will know it before you attempt to take the deduction on your tax return.
A. Providing your AGI does not exceed the contribution limit for making a RIRA contribution, you definitely should contribute to your RIRA as the future earnings are tax free upon withdrawal. Earnings withdrawn in the future from your TIRA will be taxed as ordinary income.
A. No, you may not make a TIRA contribution for this year, as this is the year you attain age 70.5. However, assuming you have earned income for this year and your AGI does not exceed the RIRA contribution maximum, you may make a RIRA contribution. Additionally, if the contribution is made before April 15, you may also make a TIRA contribution for last year, assuming you have not already contributed up to the maximum annual contribution limit.
A. Because you are now over the AGI limit for making a deductible contribution, when you amend your tax return, you will not be able to take the deduction for the TIRA contribution. You will also have to file a form 8606 with your amended return to show your increase in basis in your TIRA for this after tax (non-deductible) contribution. Also, because you are now past Oct. 15 of the year following the year of contribution, you cannot recharacterize this TIRA contribution to a RIRA contribution.
A. Yes, you did make a mistake, assuming the $22 was not an error by the employer. These small end-of-year contributions to a 401(k) from the employer are not uncommon, and may be a result of employer contributions to the accounts of non-highly compensated employees to bring the 401(k) plans into non-discrimination testing compliance or it could have been from the forfeitures of employees who left the employer without being fully vested in the employer’s past year’s contributions. The rules say that ANY contributions made to your retirement plan will make you an “active participant,” or sometimes called a “covered employee,” meaning your ability to deduct your TIRA contributions will depend on your AGI.
A. Certainly. What you want to calculate is how far into the phase-out range you are, as this will tell you how much of the total IRA contribution you make for the year will be deductible. In your case and using limit amounts for 2017, the phase-out range begins at $99,000 and ends at $119,000. The “spread” is $20,000, and you have 119,000 – 100,500 = $18,500 of “headroom” left in the phase-out range. Putting this into a percentage gives $18,500/20,000 = 92.5% of “headroom”, or 92.5% of your contribution is deductible. It follows that 0.925 X 4,000 = $3,700 each or a deduction of $7,400 on your form 1040. The remaining $300 each does not have to be contributed to your TIRAs, but instead can be contributed to your RIRAs. This makes more sense, as the future earnings of the after-tax contributions to the RIRA will not be taxable when withdrawn, while those from the TIRA will be.
Hopefully, this article and my responses to some of the questions that I encountered are helpful to understand which IRA contributions are deductible and which are not. In case of any uncertainty or ambiguity, my advice is that investors should seek assistance from a financial professional or institution that specializes in these types of retirement accounts.
In my next article, I will discuss basic rules that guide after-tax contributions to a traditional IRAs.
Bruce Miller is a certified financial planner (CFP) who also is the author of Retirement Investing for INCOME ONLY: How to invest for reliable income in Retirement ONLY from Dividends and IRA Quick Reference Guide.