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Still Time to Stash Cash in Roths and Traditional IRAs

IraAnyone who participates in a 401(k) or other retirement plan at work is also able to contribute up to $5,500 to an IRA. The IRS gives you until April 18, 2017 to make a 2016 contribution.

Question: A 23-year-old single employee contributes the maximum $18,000 to his Roth 401(k) at work in 2016, and his employer matched $9,000. So, is he allowed to make a tax-deductible contribution to an IRA too?

Answer: Yes, but the contribution to a traditional IRA may or may not be tax-deductible.

Why: The 23-year-old employee in our example is covered by a retirement plan at work.  He is only allowed to deduct his traditional IRA contribution if his modified adjusted gross income (AGI) for 2016 was less than $71,000 (because he's single). This deductible amount begins to phase out when a person’s income is $61,000 or higher. However, there’s no maximum income limit for deducting traditional IRA contributions if you aren't covered by a 401(k) or other retirement plan by an employer.

Married individuals covered by a retirement plan at work are allowed to deduct their traditional IRA contributions if their joint income was less than $118,000 in 2016. The deduction starts to phase out at $98,000. If you weren’t covered by an employer’s retirement plan but your spouse was, your IRA contributions can be tax-deductible, if your joint income in 2016 was less than $194,000 (the deduction amount starts to phase out at $184,000). There's no maximum income limit for making tax-deductible contributions, if neither spouse is covered by a work retirement plan.

Even though the 23-year-old single in our example is eligible to deduct traditional IRA contributions, he may want to contribute to a Roth IRA instead. He can’t deduct Roth IRA contributions (and his Roth 401(k) contributions are also after taxes), but the money grows tax-free for retirement. He can also withdraw his contributions without a penalty or taxes at any time. Since he's young, and his income will likely increase over time and push him into a higher tax bracket, the benefit of tax-free growth in the Roth IRA is likely to be better than the benefit of receiving a tax deduction for traditional IRA contributions now.

Studies have shown that, especially for younger investors, Roth IRAs result in much more after-tax money during retirement than traditional IRAs. If tax rates increase in the future, the Roth will be beneficial, and it has no required minimum distributions (RMDs) after you turn 70 ½.

You’re able to contribute the full $5,500 to a Roth IRA for 2016, if your modified adjusted gross income was less than $117,000 for singles or $184,000 if you’re married filing jointly. The amount you’re able to contribute phases out until your income reaches $132,000 for singles and $194,000 if married filing jointly. The income limits are slightly higher for 2017 contributions.

Reference: Kiplinger (February 3, 2017) “Deducting an IRA Contribution on Your Tax Return”

 


 

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