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February
Focus: Choosing your IRA Type
As
many taxpayers get ready to make their 2008 IRA contribution
by April 15, some will be faced with the dilemma of choosing
between contributing to a Roth IRA or a Traditional IRA. With
a Roth IRA, contributions are made with funds from earned
income that has already been taxed and qualified
distributions are tax-free. With a traditional IRA,
contributions are also made with funds from earned income that
has already been taxed, but the contributions can be
deductible. Earnings in a traditional IRA are tax-deferred
until withdrawn from the account. So how does one choose
between the two? The best way is to start by process of
elimination.
To
make the choice easier, start by determining eligibility for
the Roth IRA. Individuals whose modified adjusted gross income
(MAGI) exceed the limits shown in the chart below are
ineligible for a Roth IRA contribution. For these individuals,
the choice is simple-since they cannot fund a Roth IRA the
only option is to fund a traditional
IRA.
Tax
Filing Status |
2008
MAGI |
Single |
$116,000
or more |
Married
filing jointly |
$169,000
or more |
Married
filing separately |
$10,000
or more |
Eligible
for Both?
For
individuals who are eligible to contribute to both a Roth IRA
and a traditional IRA, the next step would be to determine
eligibility for deduction. Individuals who are active
participants in an employer plan are ineligible to deduct
their IRA contributions if their MAGIs exceed the following
amounts:
Tax
Filing Status |
2008
MAGI |
Single |
$63,000
or more |
Married
filing jointly or a qualifying widower, and
active |
$105,000
or more |
Married
filing jointly. Not active, but spouse is
active |
$169,000
or more |
Married
filing separately |
$10,000
or more |
If
an individual is eligible for a Roth IRA contribution and is
also eligible to deduct a traditional IRA contribution, the
choice is not as easy and an analysis should be done to
determine which is more suitable. Working with a financial
planner who understands retirement planning would be helpful
here, as other factors must be taken into consideration. These
include tax planning, estate planning and whether the
individual will need the assets to finance his
retirement.
For
individuals who are eligible for a Roth IRA, but are
ineligible to deduct the traditional IRA contribution, the
choice is easy: fund an IRA which yields the tax-free
earnings-the Roth IRA.
If
the individual is not eligible for a Roth IRA contribution or
a deduction for a traditional IRA contribution, a
nondeductible contribution can be made to the traditional IRA.
Distributions of nondeductible amounts are tax and penalty
free regardless of when they are distributed from the IRA, but
the earnings are taxable and subject to penalties unless an
exception applies. Note: The individual
cannot take out just the nondeductible amounts, as
distributions from the IRA are subject to the pro-rata rule
and are deemed to be partly from deductible amounts and
partly from nondeductible amounts.
The
Choice Can be Changed...
The
choice to fund a particular IRA is a reversible one.
Individuals who feel that they made the wrong choice when
funding their IRA can change the 'flavor' of the contribution
through recharacterization. For instance, if an individual
makes her contribution to a Roth IRA and later decides that a
traditional IRA would have been the better choice, she can
recharacterize the contribution to her traditional IRA. The
recharacterized contribution must include any net
attributable income, and must be completed by the
applicable deadline. For individuals who file their returns on
a calendar year basis and file their 2008 tax return on time,
the deadline is October 15, 2009. Those who file on a fiscal
year basis and file their returns on time have a six month
extension from the due date for filing their returns.
Explanations
of the rules that govern IRAs are usually
provided in Ed Slott's IRA Advisor
Newsletter. If you are not already a
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Question
of the Month
Question:
I
am ineligible for a Roth IRA contribution, and I also cannot
take a deduction for my traditional IRA contribution because I
participate in a 401(k) plan and my income exceeds the limit
for deducting contributions. I still want to fund my nest egg
and have decided to make a nondeductible contribution to my
traditional IRA. However, I am concerned that I will be
double-taxed on these amounts, as the contribution will be
made with funds that have already been taxed and distributions
from traditional IRAs are usually taxable. Is there a way I
can ensure that I am not taxed twice on these nondeductible
contribution amounts?
Answer:
Yes. You should file IRS Form 8606 with your tax return for
every year that you make a nondeductible contribution or
rollover after-tax amounts to your traditional IRA. Form 8606
helps you and the IRS to keep track of the portion of your IRA
balance that should be tax-free when distributed. Form 8606
should also be filed for any year that you take a distribution
from any of your traditional IRA, SEP IRA or SIMPLE IRA
accounts, if you have amounts attributed to nondeductible IRA
contributions or rollovers of after-tax amounts in any of your
IRAs. Roth IRAs are not counted for this
purpose.
Form
8606 includes a built in formula which helps you to determine
the portion of your distribution that is taxable (the pro-rata
rule).
News,
Rulings and Other Updates
- IRS
Extends Deadline for Completing Recharacterization of
Conversion:
In private letter ruling (PLR) PLR 200903105,
the IRS allowed the taxpayer to complete a
recharacterization of her Roth conversion, as long as it was
completed within 60-days after the PLR was issued. The
conversion was completed in 2006, which means that the
deadline for completing the recharacterization was October
15, 2007. However, the taxpayer missed the deadline due to
misleading information provided by a representative of the
IRA custodian. The IRS determined that the reason for the
taxpayer missing the deadline was attributed to the
financial institution, and granted her the extension. The
PLR was issued in 2009, which means the recharacterization
will be completed long after the statutory deadline, but
will still satisfy regulatory requirements because of the
IRS-approved
extension.
- The
IRS has issued Publication 4492-B - Information for Affected
Taxpayers in Midwestern Disaster Areas,
which explains the major provisions of the Heartland
Disaster Tax Relief Act of 2008 that apply only to the
Midwestern disaster areas. For this purpose, the publication
defines a Midwestern disaster area as "... an area for
which a major disaster was declared by the President during
the period beginning on May 20, 2008, and ending on July 31,
2008, in the state of Arkansas, Illinois, Indiana, Iowa,
Kansas, Michigan, Minnesota, Missouri, Nebraska, or
Wisconsin, as a result of severe storms, tornadoes, or
flooding that occurred on the applicable disaster date",
and includes a list of affected counties.
The
publication explains the special provisions that are available
to affected individuals for distributions and loans from
retirement accounts, as well as
rollovers.
February's
Retirement Planning Tip: Note the tax year on
your IRA contribution
When
remitting IRA contributions to your financial institution
between January 1 and April 15, be sure to note the tax year
to which the contribution applies. Many financial institutions
have default procedures for applying IRA contributions
received during this period, if the taxpayer fails to indicate
the applicable tax year. As such, failure to indicate that
your contribution is for 2008 may result in the financial
institution applying it to 2009. If you have already sent in
your contribution, check with your financial institution to
make sure it was applied to the correct year.
Highlights from Ed
Slott's IRA Advisor Newsletter - February 2009 Issue
The
February 2009 issue of Ed Slott's IRA Advisor is now
available online. The areas covered include the following:
WHAT'S
INSIDE?
Top
IRA Rulings of 2008 in this issue. See our 2008
recap from the nation's leading IRA experts.
Also -
2009 brings us the largest ever increase in the federal estate
tax exemption (from $2 million to $3.5 million) at a time
where most estates have been significantly reduced due to the
stock market meltdown. This month's Guest IRA Expert Blanche
Lark Christerson, JD, LLM, from Deutsche Bank Private Wealth
Management, New York covers critical new estate planning
concerns that will affect many of your clients this
year.
WHAT'S INSIDE?
Feature
Article Top IRA Rulings of
2008
- 2008
Tax Legislation
- Court
Decisions
- IRS
Notice 2008-30
- IRS
Private Letter Rulings
- Salvaging
72(t) Payment Plans
- Saving
the Stretch IRA
- Identifying
the Beneficiary
- Disclaimer
Rulings
- IRA
Trust Rulings
- Congress:
Coming Attraction
Guest
IRA Expert Blanche Lark Christerson, JD, LLM Deutsche
Bank Private Wealth Management, New York
Estate
Planning with the $3.5 Million
Exemption
- The
Impact of the Increased Exemption
- The
Clients in the Middle
- Flex
Plans
- Integrating
an IRA
- Advisor
Action Plan
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