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IRA Rules

2017 IRA Contribution Reminder

It's not too late to make an IRA contribution for 2017. The deadline is the tax filing date which is Tuesday 4/17/2017 this year however we recommend not waiting 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 2017 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 2017.

Anyone is eligible to make a Traditional 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. Many are not aware that there is no age limit to make Roth IRA contributions, so if you are still working and your income is below the limit, then you can contribute to a Roth IRA.


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 $99,000- $119,000; 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 $62,000- $72,000; 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 $186,000 - $196,000. 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 $186,000 - $196,000 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 $118,000- $133,000. 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.


Traditional IRA vs. Roth IRA

The question of whether to contribute to a Traditional IRA or a Roth IRA is very common. The basic difference is that a Traditional IRA contribution can entitle you to a tax deduction for the amount contributed, unless your income is above the limits to take a deduction. Deductible or not, the earnings grow tax deferred which means that when the money comes out, the earnings will be taxable at your top marginal tax rate prevailing at the time. A Roth IRA on the other hand is a tax-free account. Contributions are made with funds that have already been taxed and so when the contributions come out there is no tax to pay. The earnings also grow tax-free which is what makes the Roth IRA so great.

The common thought is that we will have less income in retirement and thus a lower marginal tax bracket so it makes sense to get a tax break now and pay it later. But what if your tax rate is not lower in retirement? This can happen if you have enough taxable income from Social Security, pensions, required minimum distributions from IRA, and other taxable income sources. The other possibility is that tax rates in general are higher than they are now. For those who believe the government debt is out of control, and cannot get out of it just through growth might believe that taxes must go up in the future to pay for the massive debt we have. If either of these might apply to you then a Roth might be a good decision. If you think your tax rate may be higher in retirement then we can make the case that a Roth IRA is better for you. There is also a case to be made for tax diversification if you do not have a strong conviction on which direction taxes will go. Estimating this requires some analysis so if you're not sure give us a call and we'll help you make that decision.


IRA to Roth Conversions

Since 2010 anyone regardless of income can convert an IRA to a Roth IRA. This also 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.

Roth conversions can only be done for the calendar year in which the conversion is made which means there are no more 2017 Roth conversions. Also with the updated tax law, congress has removed the ability to recharacterize (unwind as if it never happened) a Roth conversion, so going forward, if you want to convert to a Roth IRA, be sure it is the right decision and the right amount because you're stuck with it once it's done, no do-overs.


Spousal IRA Contributions

What if you or your spouse does not work, can you still make an IRA contribution? The answer is yes! As long as one spouse has enough earned income to make the IRA contribution, then you can make a spousal contribution. This means $5,500 for you and $5,500 for your spouse. The $1,000 catch-up contribution applies here as well.

Many are familiar that when they reach age 70 ½ they cannot contribute to an IRA anymore which is true for a Traditional IRA, but not a Roth IRA. If you are over 70 ½ but your spouse is still working, they can make a Roth IRA contribution for you.


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 $54,000 for 2017 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.


2017 IRA Limits

For 2017, 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 2016 with a few exceptions:

  • IRA deduction phase-out for active plan participants
    • Single $62,000-$72,000
    • Married filing jointly $99,000-$119,000
    • Married filing separately $0-$10,000
    • Spouse is not covered by a plan $186,000-$196,000
  • Roth IRA phase-out
    • Single $118,000-$133,000
    • Married filing jointly $186,000-$196,000

For more information, download a copy of the 2017 Retirement Plan Contribution Limits chart.

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If you have any questions about IRA contributions or wish to make an IRA contribution for 2017 give us a call.

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