It’s the time of year when IRA contributions are on many people’s minds—especially those doing their tax returns and looking for a deduction. The deadline for making IRA contributions for the 2016 tax year is April 18, 2017.
Chances are, there may be a few things you don’t know about IRAs. Here are seven commonly overlooked things about IRAs.
|1.||Even if you don’t qualify for tax-deductible contributions, you can still have an IRA.|
If you’re covered by a retirement savings plan at work—like a 401(k) or 403(b)—and your 2016 modified adjusted gross income (MAGI) exceeds certain income limits, your contribution might not be tax deductible.1 But getting a current-year tax deduction isn’t the only benefit of having an IRA. Nondeductible IRA contributions still offer the potential for your money and earnings to grow tax free until the time of withdrawal. You also have the option of converting to a Roth IRA (see No. 7, below).
|2.||A nonworking spouse can open and contribute to an IRA.|
Non-wage-earning spouses can open and contribute to their own traditional or Roth IRA, provided the other spouse is working and the couple files a joint federal income tax return. A nonworking spouse can contribute as much to a spousal IRA as the wage earner in the family. For 2016 and 2017, the IRA contribution limits are $5,500, or $6,500 for those over age 50.
|3.||Alimony counts as earned income.|
Although former spouses receiving alimony might not like having to pay tax on these payments, the fact that alimony counts as earned income may qualify them to contribute to an IRA. Keep in mind, however, that tax-deductible contributions to an IRA can’t exceed total taxable earned income. So if the total of your alimony payments and other taxable earned income is less than $5,500 ($6,500 if you’re 50 or older), your deductible IRA contribution will be limited to the lower amount.
|4.||Self-employed, freelancer, side gigger? Save even more with a SEP IRA.|
If you are self-employed or have income from freelancing, you can open a Simplified Employee Pension plan—more commonly known as a SEP IRA. Even if you have a full-time job as an employee, if you earn money freelancing or running a small business on the side, you could take advantage of the potential tax benefits of a SEP IRA. The SEP IRA is similar to a traditional IRA where contributions may be tax deductible—but the SEP IRA has a much higher contribution limit. The amount you can put in varies based on your earned income. For SEP IRAs, you can save 25% of pretax income up to a $53,000 limit for 2016 and a $54,000 limit for 2017 contributions. The deadline to set up the account is the tax deadline—so for 2016 it will be April 18, 2017 (for a calendar-year filer). But, if you get an extension for filing your tax return, you have until the end of the extension period to set up the account or deposit contributions.
|5.||"Catch-up" contributions can help those age 50 or older save more.|
If you’re age 50 or older, you can save an additional $1,000 in a traditional or Roth IRA each year. This is a great way to make up for any lost savings periods and make sure that you are saving the maximum amount allowable for retirement. For example, if you turn 50 this year and put an extra $1,000 into your IRA for the next 20 years, and it earns an average return of 7% a year, you could have almost $44,000 more in your account than someone who didn’t take advantage of the catch-up contribution.2
|6.||You can open a Roth IRA for a child who has taxable earned income.3|
Helping a young person fund an IRA—especially a Roth IRA—can be a great way to give him or her a head start on saving for retirement. That’s because the longer the timeline, the greater the benefit of tax-free earnings. Although it might be nearly impossible to persuade a teenager with income from mowing lawns or babysitting put part of it in a retirement account, gifting the contribution to an IRA on behalf of a child or grandchild can be the answer. The contribution can’t exceed the amount the child actually earns, and even if you hit the maximum annual contribution amount of $5,500, that’s still well below the annual gift tax exemption ($14,000 per person in 2016 and 2017).
The Fidelity Roth IRA for Kids, specifically for minors, is managed by an adult until the child reaches the appropriate age for the account to be transferred into a regular Roth IRA in his or her name. This age varies by state. Bear in mind that once the account has been transferred, the account’s new owner would be able to withdraw assets from it whenever he or she wished, so be sure to educate your child about the benefits of allowing it to grow over time and about the rules that govern Roth IRAs.
|7.||Even if you exceed the income threshold, you might still be able to have a Roth IRA.|
Roth IRAs can be a great way to achieve tax diversification in retirement. Distributions of contributions are available any time without tax or penalty, all qualified withdrawals are tax free, and you don’t have to start taking minimum required distributions at age 70½.4 But some taxpayers make the mistake of thinking that a Roth IRA isn’t available to them if they exceed the income thresholds.5 In reality, you can still establish a Roth IRA by converting a traditional IRA, regardless of your income level.
If you don’t have a traditional IRA you’re still not out of luck. You could open a traditional IRA and make nondeductible contributions, which aren’t restricted by income, then convert those assets to a Roth IRA. If you have no other traditional IRA assets, the only tax you’ll owe is on the account earnings between the time of the contribution and the conversion. However, if you do have deductible contributions in another IRA, you’ll need to pay close attention to the tax consequences. That’s because of an IRS rule that calculates your tax liability based on all your traditional IRA assets, not just the after-tax contributions in a nondeductible IRA that you set up specifically to convert to a Roth. For simplicity, just think of all IRAs in your name (other than inherited IRAs) as being a single account. For more information, read Viewpoints: “Answers to common Roth conversion questions.”
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