It's not too late to make an IRA contribution for 2015. The deadline is the tax filing date which is Monday 4/18/2015 this year however generally it is not a good idea to wait until last minute.
Individual Retirement Accounts (IRA) are tax deferred, or in the case of a Roth IRA, tax-free savings/investment accounts. Tax deferral allows your money to grow faster without losing some of the growth annually to taxation. Having investments in an IRA also allow you greater investment flexibility to make changes without having to worry about generating any taxable capital gains transactions.
The IRA contribution limit for 2015 is $5,500 to any combination of IRAs and/or Roth IRAs as long as the total doesn't go above $5,500 unless you qualify for the catch-up contribution which is an additional $1,000 if you reached age 50 by year-end 2015.
Anyone is eligible to make an IRA contribution as long as you have earned income and you are under 70 1/2; whether you can take a deduction for a traditional IRA depends of a few factors described below. Eligibility to contribute to a Roth IRA depends on income which is also described below; there is no age limit to make Roth IRA contributions.
Phase-Out Range for IRA Deductibility: If you are considered an active participant in a company retirement plan, your deductibility for an IRA may be limited. If you are married filing jointly the phase-out for deductibility begins for adjusted gross income between $98,000- $118,000; above that there is no deduction. If you are a single or head of household filer the phase-out for deductibility begins for adjusted gross income between $61,000- $71,000; above that there is no deduction. If you are not covered by a company plan but your spouse is, the phase-out range for you is $183,000 - $193,000. If you file married-separate, your phase-out range is $0 - $10,000. If your income falls between the phase-out range, your ability to deduct your IRA contribution will be limited. There is a specific calculation to determine the amount you can deduct so if this applies to you, consult your tax advisor to determine how much you can deduct.
Even though you may not participate in the company plan, you may be considered an "active participant” so it is important to verify before attempting to take a deduction. If you and your spouse (if applicable) are not covered by a company plan, then there is no income limitation to take a deduction for an IRA contribution. SEP and SIMPLE IRAs are considered company plans for these purposes but are not included in the maximum contribution amount as they have their own limits.
Eligibility for Roth IRA Contribution: If you are married filing joint, the phase-out of eligibility to contribute to a Roth IRA is between $183,000 - $193,000 of adjusted gross income; above that you cannot make a Roth IRA contribution. For single or head of household filers, the phase-out for eligibility is $116,000- $131,000. If you file married-separate, your phase-out range is $0 - $10,000. As mentioned above, if your income falls between the phase-out range, then your ability to contribute to a Roth IRA is limited. If you are above, then you cannot contribute directly to a Roth IRA however you are still able to convert IRA funds to a Roth IRA which is discussed below.
Non-deductible IRAs: If you wish to make a deductible IRA contribution but make too much income to be eligible to take a deduction, consider a Roth IRA instead. If your income is above the threshold to make a Roth IRA contribution, you can still make a regular IRA contribution however that contribution will not be deductible. In such a case of a non-deductible IRA contribution, your money goes in after tax but still grows tax deferred and your contributions when withdrawn are not taxable however the interest/gains will be taxable upon withdrawal.
These non-deductible contributions create "basis” in your IRA which when withdrawn come out tax-free in a pro-rata distribution relative to the amount of pre-tax money in your IRA. For example, if you have $100,000 in your IRA, $10,000 of which is after-tax basis, your ratio would be 10%. If you then took a distribution/conversion of $25,000, $2,500 of that would be considered a return of your basis tax-free while the $7,500 would be taxable.
IRA to Roth Conversions: Since 2010 anyone regardless of income can convert an IRA to a Roth IRA. This means that you could make a non-deductible IRA contribution and convert it to a Roth thereby getting after-tax funds in a Roth IRA which is in essence the same as making a Roth IRA contribution. This strategy is referred to as the “Back Door Roth.” It only works if you do not have other IRA funds because if you do, the pro-rata rules described above would apply. It is unknown if this loophole will be closed by congress or if they will allow anyone regardless of income to make a Roth IRA contribution; only time will tell. For now it is still there and people who this applies to should consider taking advantage of this great tax planning opportunity.
Mega Backdoor Roth: The “Mega Backdoor” Roth is similar to what is described above however it is related to employer plans. There are many rules and details to be aware of but the basic idea is this: if the employer plan allows for after-tax contributions, you can theoretically contribute after tax funds up to the maximum Defined Contribution plan limit which is $53,000 for 2015 and 2016 plus $6,000 catch up contribution if over 50. Then, if the plan allows, you can request a distribution of only the after-tax funds paid to you and then deposit to a Roth thereby completing a Roth conversion of after-tax funds which means getting a whole lot of money in a Roth IRA, far more than the statutory annual contribution limit which also is limited by income levels.
For example, suppose you are maxing out your 401k at $18,000 and your employer provides a $6,000 contribution for you. That means $24,000 has been contributed leaving an additional $29,000 that could be put in using after-tax funds ($35,000 if over 50). If you had the ability to, you could contribute that $29,000 from your paychecks and at some point then request a distribution of those after-tax funds and convert to your Roth IRA. That would mean getting $29,000 in a Roth IRA in one year! Well you might say, “I have bills to pay and can’t take that much out of my checks.” Well obviously if you don’t have the funds you can’t do this but suppose you do have $29,000 in a savings or taxable investment account. In that case you would increase your contributions to the plan and use your savings to pay the bills and essentially shifting those taxable savings/investments into tax-free Roth IRA accounts. That’s why this is called the “Mega” backdoor Roth. Certainly many details are left out but this is the basic idea. If you think this could apply to you be sure to give us a call to discuss.
2016 IRA Limits: For 2016, IRA contributions limits stay at $5,500 if under 50 with the additional $1,000 catch-up contribution if you reach age 50 by year end. The phase-outs for IRA deductibility and Roth IRA stayed mostly the same from 2015 with a few exceptions:
- IRA deduction phase-out for active plan participants
- Single $61,000-$71,000
- Married filing jointly $98,000-$118,000
- Married filing separately $0-$10,000
- Spousal IRA $184,000-$194,000 (you are covered but your spouse is not)
- Roth IRA phase-out
- Single $117,000-$132,000
- Married filing jointly $184,000-$194,000
If you have any questions about IRA contributions or wish to make an IRA contribution for 2015 give us a call.