Long-Time Financial Advisor Makes Rookie IRA Contribution Mistake

By Beverly DeVeny, IRA Technical Expert
Follow Me on Twitter: @BevIRAEdSlott

In a just released private letter ruling (PLR), a taxpayer was given an extension of time to complete a rollover of funds to his IRA. He was given bad advice by his CPA.

“Tom” transferred some funds from an existing IRA to a brand new IRA. At tax time, his CPA of 20 years thought the transfer was a contribution. He advised Tom that he could not make a “new” IRA contribution because he was participating in his employer plan at work. And, if the contribution remained in his IRA, it would be considered an excess contribution, subject to a penalty of 6% per year until it was removed. Tom removed the funds from the IRA and placed them in a non-IRA account.

Two years later, Tom got a love letter from IRS wondering where the taxes were on his IRA distribution. The problem was the incorrect advice from Tom’s CPA. We don’t know why the CPA thought the transfer was a contribution to the IRA. But then the CPA made the rookie mistake. He told Tom he was ineligible to make a contribution to his IRA because he was participating in an employer plan. That is where he made his big mistake.

As long as an individual is under age 70 ½ for the entire year and has earned income, he or she can make an IRA contribution. Plan participation, even in a SEP or a SIMPLE IRA, has no impact on the ability to make an IRA contribution. It does, however, impact an individual’s ability to deduct the contribution. There are income limits for deducting an IRA contribution when an individual is covered by an employer plan. The limits are indexed each year for inflation. You can find the current limits on the IRS website, www.irs.gov, in Publication 590-A.

We get frequent questions in this area. Don’t make this mistake for yourself or your clients.