Most tax decisions must be made prior to year-end each year. One important exception for clients to know is that the filing deadline for Individual Retirement Account (IRA) contributions falls on the same day as tax day. Tax day is normally April 15, but this year, taxpayers and preparers get a three-day bonus – it’s April 18. While you may extend a client’s tax return filing deadline, you cannot extend the IRA contribution deadline. There is no carry forward provision, making it a use it or lose it situation.
Like all tax laws, there are exceptions. You may explore the exception details by referring to the following links. For now, we will stick to the fundamental possibilities, beginning with the essentials. IRA deduction limits are varied. For 2016, as in 2015, total contributions to traditional and Roth IRAs cannot exceed $5,500, or $6,500 if your client is 50 or older. However, the IRA contribution limit does not apply to rollover contributions. Traditional IRA contributions are only tax deductible based on certain limits and income levels.
The principal difference between a traditional IRA and a Roth IRA is when they are taxed. The traditional IRA contribution may be tax deductible in the year contributions are made and taxable when the funds are distributed. With a Roth IRA, contributions are made with after-tax dollars and are tax free when distributed. Both enable the investments within them to grow tax free. A cursory review of a client’s IRA situation may present four useful tax-planning tips for growing retirement funds.
Tax Tip Number 1: IRA in Addition to Retirement Plan at Work Clients may be eligible to contribute to an IRA, in addition to participation in another retirement plan at work. For example, a client may still deduct contributions to a traditional IRA if the client’s modified adjusted gross income (MAGI) is under $98,000 for a married taxpayer filing jointly. A contribution to a Roth IRA is affected by the amount ofMAGI calculated specifically for Roth IRA purposes.
Tax Tip Number 2: Spousal IRA Married taxpayers who have no taxable compensation are able to contribute to an IRA, as long as the spouse has taxable compensation. The amount of their combined contributions can’t be more than the taxable compensation reported on their joint return. See theformula in IRS Publication 590-A for details.
Tax Tip Number 3: Converting IRAs to Roth IRAs Before 2010, taxpayers earning more than $100,000 were restricted from converting their traditional IRAs to Roth IRAs. Therefore, you may need to update clients about the possibilities this provides.
Although converting a traditional IRA to a Roth IRA must take place by Dec. 31, now is still a great time to consider the tax consequences for 2016. If your client converts before Dec. 31, and then determines the extra tax could be reduced by shifting to a later year, the client is able to reverse the decision. Taxpayers have until Oct. 15 of the following year to “recharacterize” a Roth conversion back to the traditional IRA without taxes or penalty.
Earned income is needed to make new contributions to a Roth IRA. This doesn’t apply when converting from a traditional IRA to a Roth. Clients may convert regardless of age or income. Tax must be paid in the year of conversion, except for the nondeductible contributions made to the traditional IRA. In addition, Roth IRAs do not have required minimum distributions and can be inherited tax free.
Have clients consider IRA conversions during a low-income year. Consider the dollar savings of timing conversions over several years, which may avoid the Medicare high-income surcharge. This tactic also avoids Part B and Part D premiums if an adjusted gross income exceeds $85,000 for single or $170,000 for married taxpayers. Note that taxpayers under age 59 ½ must wait five years, or reach age 59 ½, before withdrawing the converted amount without the 10 percent penalty.
Tax Tip Number 4: Non-deductible Contributions If your client exceeds the income-based limits, a nondeductible traditional IRA contribution may be made and then converted to a Roth at a later time. Also note that a client who reaches 70 ½ may no longer make regular contributions to a traditional IRA but continue to contribute to a Roth IRA.
Tax law is fraught with exceptions and subjective cases. Be sure and refer to tax research, or to IRS publications, to ensure your clients are in compliance:
- Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs)
- Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs)
- Retirement Plans FAQs regarding IRAs
- IRA Year-End Reminders
Not all of these options will reduce a client’s tax liability. The long-term goal is tax-deferred or tax-free growth.