I like focusing on IRAs in February because of the planning opportunities available for both the prior and current year. To keep us all on the same page, IRA stands for Individual Retirement Account. These accounts have been around since established by the Employee Retirement Income Security Act of 1974 (ERISA) and are still highly misunderstood. I’ve had folks argue with me that they have a joint IRA. Not possible. That’s what the ‘I’ stands for. Some people still believe that if they participate in a workplace retirement plan, that they cannot have an IRA. Again, not true. Deductibility and participation are guided more so by income level. Income may determine whether you can make a deductible contribution to a traditional IRA or not. Or, if you can even participate in a Roth IRA (not tax deductible) without a conversion or ‘backdoor’ maneuver.
For a traditional IRA, you do need to consider if you, or your spouse, are covered by a workplace retirement plan. But it doesn’t mean that you can’t contribute. Contribution rules can get complicated pretty fast, so if you are not sure, please ask me. Your modified adjusted gross income (MAGI), type of workplace plan, and who is covered by that workplace plan (you, your spouse, both) matters.
Now, about those planning opportunities for the prior year and the current year. You have until tax filing day in April to make contributions to your IRA for the prior year if you didn’t make the maximum contribution. Keep in mind that for a traditional IRA the contribution must be made prior to finalizing and submitting your tax return. For a Roth IRA, the contribution only needs to be made by tax filing day even if you have already filed your return. Crazy, right? I guess Congress likes making things confusing.
For a traditional IRA and a Roth IRA, the maximum total contribution is $6,000 ($7,000 age 50+) per year for either IRA type. Whether deductible or not for a traditional IRA depends on the aforementioned factors (MAGI and workplace plan participation), but you can still contribute even if it’s not deductible. You cannot, however, contribute the maximum to both IRA types if you happen to have both types. If you have both types of IRAs, the maximum combined contribution across both cannot exceed $6,000 ($7,000 age 50+) total between the two accounts.
Why focus on funding your IRA for the prior year? Well, there are a few good reasons. First, you may be eligible for a tax deduction with the traditional IRA if you fall in the income range. This would help reduce any tax you owe. Even if you are not eligible for the deduction, use up the prior year’s total contribution amount. That way you still have the ability to fully fund your IRA for the current year. With the Roth, the funding reason applies (but not the deductibility). That way you have the ability to fully fund your account for the current year. Another key reason is the five-year rule for the Roth IRA. If you have time to fund your Roth for the prior year, the five-year clock starts as of January 1 regardless of contribution date for the year. Setting this clock as soon as possible is a good strategy. Remember, the five-year rule is key to avoiding a penalty tax on future Roth withdrawals.
Remember, for 2021 the maximum contribution is $6,000 ($7,000 age 50+). For 2021, the married filing jointly income limit provides for a full contribution up to $198,000 MAGI, reduced between $198,000 and $207,000 MAGI and no contribution if over $207,000. For single filers, up to $125,000 MAGI for a full contribution, but reduced between $125,000 and $139,000 MAGI. No contribution for single filers over $139,000. Note, these income limits are not applicable to backdoor Roth conversions.
Looking ahead at planning for 2022, income limits are as follows. For single filers, a full contribution up to $129,000 MAGI and a reduced contribution between $129,000 and $144,000 AGI. For married filing jointly, a full contribution up to $204,000 MAGI and a reduced contribution between $204,000 and $214,000 MAGI.
One last note for those considering a backdoor Roth (or any Roth conversion). If you have any other existing IRAs, of any type, this could trigger the pro-rata rule and be a taxable event. For example, if you have an existing traditional IRA with a $94,000 balance and decided to make a non-deductible $6,000 contribution and immediately convert that amount, the IRS views this as a $100,000 total IRA balance. The $6,000 being converted to the Roth represents 6% of your total balance ($6,000/$100,000). Therefore, $360 would be tax-free and you would owe tax on the $5,640 converted to Roth.
As an independent CERTIFIED FINANCIAL PLANNER™, I can help you plan for retirement or other goals. Contact me and let’s get started on a savings, investing, or retirement plan, or a walk! #talktometuesday #education #Hireaplanner #stressfree #IRA #Roth #savings #retirement #CFPPro