Even though the new year has begun, it may not be too late to make a traditional IRA contribution for the last tax year — if you’ve not already done so. The contribution deadline is April 15. If you qualify for a deductible contribution, you can lower last year’s tax bill by taking action by then. You may also qualify to make a deductible contribution for the current tax year, which you can do anytime between now and April 15 of the following year. Here’s the scoop on traditional IRA contributions.
With a deductible traditional IRA contribution, you can effectively finance part of your pay-in with the current tax savings. However, if you expect to pay the same or higher tax rates during your retirement years, you’re probably better off making a nondeductible contribution to a Roth IRA (assuming you qualify). With a Roth account, the tax-saving payoff comes at the back end when you become eligible for tax-free withdrawals during retirement.
The absolute maximum amount you can contribute for any tax year to a traditional IRA is the lesser of: (1) your earned income for that year or (2) the annual contribution limit for that year. Basically, earned income means wage and salary income (including bonuses), alimony received, and self-employment income.
If you’re a married joint-filer, both you and your spouse may be able to make deductible contributions to your own separate accounts. For purposes of the aforementioned earned income limitation, you can add your earned income to that of your spouse. For example, say your joint earned income and adjusted gross income (AGI) is $80,000, but none of that was earned by your spouse. No problem. You can make a deductible traditional IRA contribution and your spouse can do the same by contributing to his or her separate account. This is possible because your combined earned income ($80,000) exceeds your combined contributions.
You can’t make a traditional IRA contribution for the year when you turn 70½ or for any subsequent year. However as long as you have earned income, you’re potentially eligible for Roth contributions. Age is not a factor for them.
Assuming you have enough earned income, you can contribute to a traditional IRA. The real question is: Will your contributions be deductible? The answer depends on whether you participate in a tax-favored retirement plan and your income. The rather complicated eligibility rules for deductible contributions go like this:
If you or your spouse were an active participant in a tax-favored retirement plan through your job or self-employment your eligibility to make a deductible contribution to a traditional IRA could be phased out (reduced or eliminated) depending upon your Modified Adjusted Gross Income (MAGI).
If you’re not an active retirement plan participant for the year in question, the phase-out rule is not applicable. You can make deductible contributions no matter how high your income.
Figuring your MAGI
You start off with the adjusted gross income number from the last line on page 1 of your Form 1040. Then you add back several tax breaks, only some of which may apply to you. This is all taken into account if you use the worksheet on pages 31 and 32 of your Form 1040 package to calculate your deductible traditional IRA contribution amount (if any).
If the MAGI phase-out rules make you ineligible for a deductible traditional IRA contribution, check to see if you can make a Roth contribution for the year (the phase-out rules are more forgiving). If not, consider the last resort of making a nondeductible traditional IRA contribution. At least you can defer taxes on the resulting earnings. Not a great deal, but better than nothing.
On your 2009 Form 1040, report any deductible traditional IRA contributions on page 1, line 32. If you make any nondeductible contributions, they are not reported on the Form 1040 itself, but you must file Form 8606 (Nondeductible IRAs) with your return. Form 8606 keeps track of your cumulative nondeductible contributions, which is a good thing because they count as tax-free amounts when they are withdrawn.
Please note that the content of this blog does not constitute tax advice and is only intended for the educational purpose of the reader. Please consult your tax advisor for specifics regarding your circumstances.
For more information contact us at 845.563.0537 or Contact@CompassAMG.com
The author of this blog, Steven M DiGregorio is President of Compass Asset Management Group, LLC and an Investment Advisor Representative with Spire Wealth Management, LLC a Federally Registered Investment Advisory Firm. Securities offered through an affilliated company Spire Securities, LLC a Registered Broker/Dealer and member FINRA/SIPC.