United States: Making Meaningful IRA Contributions Is Easier Than Ever

Over the years, the rules governing IRA contributions have been relaxed somewhat to encourage greater participation. In 2002, individuals could contribute a maximum of $2,000 a year to a traditional IRA and strict income limits applied to those covered by another retirement plan. However, for 2016, income limits are more generous and you may be able to contribute up to $5,500 a year combined to a traditional and/or Roth IRA.

So if you may have dismissed IRAs in the past, you may want to take a fresh look at these valuable tax-advantaged savings vehicles.

Traditional Benefits
Contributions made to a traditional IRA may be deductible and account funds grow tax-deferred. No tax is due until withdrawals are made — likely in retirement when you might be in a lower tax bracket.

If you are age 50 or older you can make "catch-up" contributions. For 2016, that is $1,000 a year, for a total IRA contribution of $6,500. Spouses can each contribute $5,500 a year for a total of $11,000 (or up to $13,000 with catch-up contributions) per couple.  If only one spouse has earned income the non-working spouse can contribute to a spousal IRA.  You must be married, file a joint return and family-earned income must be enough to qualify for both contributions.

Note that you must have earned income at least equal to what you contribute to your IRA. And, if you are age 70½ or older, you cannot contribute to a traditional IRA.

Limits on Deductibility
Although more people are eligible to make deductible contributions to traditional IRAs than in the past, income limits still apply. For the 2016 tax year, if you are single and participated in an employer-sponsored retirement plan (such as a 401(k) plan), your eligibility to deduct your traditional IRA contribution will begin to phase out (or gradually be reduced) if your adjusted gross income (AGI) exceeds $61,000. It will be eliminated if your AGI exceeds $71,000.

AGI phase-out amounts for married couples vary. If you and your spouse both participated in an employer-sponsored plan in 2016, your phase-out range for making deductible contributions is $98,000 to $118,000 joint AGI. This limit applies to both spouses. If only one of you was covered by an employer-sponsored retirement plan, only that spouse is subject to the $98,000 to $118,000 joint AGI phaseout range. For 2016, the non-covered spouse's phase-out range is $183,000 to $193,000 joint AGI.

Even if you run up against income limits, you can still contribute to an IRA — your contributions just won't be deductible. However, you still benefit from tax deferral because you will not have to pay tax on your contribution's earnings until you make IRA withdrawals in retirement.  In the case of a non-deductible IRA contribution it may make sense to convert to a Roth IRA as there will be not additional tax levied upon conversion.

Roth Rules
Contributions to Roth IRAs are not deductible — regardless of your income level or participation in an employer-sponsored plan. However, qualified withdrawals are tax-free, meaning that account earnings can avoid tax permanently.  Also, withdrawal of principle amounts are always tax-free as they have already been taxed.

Roth IRAs offer other benefits, as well. Those 70½ years-old and older can make Roth IRA contributions as long as they have earned income equal to those amounts. Also, Roth IRAs are not subject to the required minimum distribution (RMD) rules that apply to traditional IRAs (and most employer-sponsored plans). So, if you do not need the money during your retirement, you can let the account continue to grow tax-free for the benefit of your heirs. (Heirs other than spouses will be subject to RMD rules, however.)

Although Roth IRAs share annual contribution limits and deadlines with traditional IRAs, Roth income limits are higher. If you are single, your phaseout range for eligibility to make Roth contributions for the 2016 tax year is $116,000 to $131,000 AGI. For married joint-filing couples, it is $183,000 to $193,000 joint AGI.

Tax-free withdrawals and lack of RMDs can make converting a traditional IRA to a Roth IRA a good idea for some retirement savers. There is no income limit on conversions. However, in the year of conversion, you will owe income tax on the amount converted, except in the above mentioned example of a non-deductible IRA.

Take Another Look
If income and other restrictions have led you to bypass IRAs in the past, it may be time to reconsider them. You might now be eligible to deduct traditional IRA contributions or make Roth IRA contributions. You have until April 16, 2017, to make 2016 tax year contributions. However, the sooner you contribute, the sooner you put your money to work. Talk to your financial advisor to learn how an IRA might help you realize untapped tax benefits and what role it might play in your larger retirement-savings strategy.  Consult your CPA for explanation of rules and benefits.

Sidebar: Watch Out for New Rollover Limits
The IRS has clamped down on the number of tax-free IRA rollovers individuals can make in any one-year period. Effective for IRA withdrawals taken in 2016, you can execute only one traditional IRA rollover in a 365-day period, regardless of how many traditional IRAs you own.

This restriction does not apply to trustee-to-trustee direct transfers between traditional IRAs or rollovers into IRAs from qualified retirement plans, such as 401(k)s. You can make as many of these tax-free transactions as you wish.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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