This time of year is a good time to be an accountant – once we are past the hustle and grind of tax season, we can take time to look at client’s tax planning options and help them formulate a plan to save real dollars, while preparing them for the future. Most times, these plans include some form of retirement savings. Congress has incentivized us to save for retirement in so many ways within the tax code; any prudent individual should take the time to know the ins and outs of his or her options.
A traditional IRA operates in many ways like a 401(k). If neither you nor your spouse is covered by an employer’s retirement plan, you may contribute up to $5,500 each for 2015 ($6,500 if over age 50), subject to some contribution rules outside the scope of this article. This amount is entirely deductible as an above-the-line adjustment, meaning you do not need to itemize your deductions to see tax benefits. If you or your spouse is covered by an employer’s plan, though, the amount deductible begins to phase out, or reduce as your Modified Adjusted Gross Income increases from $183,000-$193,000 in 2015. Above $193,000, you will not have any deduction for IRA contributions. If you are both covered by an employer’s retirement plan, the phase out range is reduced to $98,000-$118,000. Contributions can be made up until the filing deadline (without extension) of the tax return for the year in question (for example, April 18th, 2016 for the 2015 tax year).
When you withdraw from a traditional IRA, if all contributions were deemed deductible, the entire distribution is taxable as ordinary income. However, if a portion or all of your contributions were non-deductible, you are deemed to have basis in the IRA for that amount, less any basis withdrawn from previous non-deductible contributions. When you recover basis, it is not taxable – only the growth of the investment is taxable. To track this IRA basis from year to year, you or your tax preparer should file Form 8606 for every year for which you contribute or maintain an IRA with basis. In the Alpern case, a taxpayer was unable to provide proof (i.e., Forms 8606) showing he had basis in his IRA, and the entire distribution was deemed taxable.
Another course of action for individuals is a Roth IRA. Relatively new to the tax code and investment strategy, a Roth IRA (and it’s 401(k) counterpart) allow for post-tax contribution of money, and ensuing distributions are 100% tax free (yes, even the gains on investment!). To qualify for the tax free treatment, the account must be held for 5 years, and distributions must be made after age 59 ½. The Roth IRA follows the contribution rules of the Traditional IRA in amounts and timing, however, Roth contributions are not allowed for Modified Adjusted Gross Incomes in excess of $193,000 for 2015. In that case, your only plan as it relates to IRAs is a non-deductible traditional contribution.
For Self-Employed individuals, SEP IRAs and SIMPLE IRAs are options which can allow for the deferral of large amounts of money (up to $53,000 for 2015, subject to limitations).
These plans also allow you to help employees invest in their retirement without many of the costly constraints and red tape of a 401(k) plan, as well.
These rules are often very complex, so it makes sense to talk to your tax advisor regarding these rules before getting started.
By Brock R. Yates, CPA