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It’s tax time and with that comes decisions on making contributions to Individual Retirement Accounts (IRAs). Here are some common mistakes individuals have made regarding maximizing their retirement contribution opportunities:
1. Waiting Until The Tax Return Deadline
Some tax payers wait until their tax return due date (April 18th) to make their IRA contribution. The common statement they usually make is "I don’t know what IRA I should contribute to” or “my tax advisor hasn't told me what type of IRA I should contribute to." Making a contribution to an IRA as early as possible has no repercussions since there are remedies to changing the type of contribution made to the wrong IRA. Making the contribution to any IRA as early as possible means that the earnings in the IRA are already growing on a tax-deferred basis.
If later the tax payer determines that the contribution was made to the wrong IRA, whether whole or in part, they may move the contribution along with its earnings to the appropriate type of IRA as long as it is done on or before their tax return due date (plus extensions). This mechanism allowed by law is called a recharacterization. A tax payer would only need to contact the custodian or trustee of their IRA and, most if not all, should be able to walk them through the process.
2. Contributing Too Much
Individuals may make contributions throughout the year, but they don't always keep track of contributions they may have made to their IRAs. It is important not only to keep track of contributions that have been made but also to what type of IRA it has been made to. The maximum limit for 2016-2017 is $5,500 for someone who is under the age of 50 and $6,500 for persons age 50 and over, for each year. This limit is shared by both the Traditional IRA and Roth IRA. Shared means any variations of contribution amounts may be made to each type of IRA as long as if combined it does not exceed the limit.
Since each contribution must also be associated with the year for which the contribution is being made, it is best that the taxpayer communicates with the financial organization for which year they are making their contribution. Failing to state the year their contribution is made for may cause doubling up on a contribution for a particular year and cause overcontributing to their IRA.
3. Not Understanding the Rules
We have often heard individuals say that their tax advisor said they are not eligible to make an IRA contribution because they have made too much money for the year. In addition, they were told that they're not eligible because they participate in an employer sponsored plans such as a 401(k) plan. These two statements are totally incorrect and are just some of the misinformation that is floating around.
Here is a recap of the rules:
- For Traditional IRAs, you must be under the age of 70 ½ in the year or which you are making the contribution.
- You must have earned income, and there is no income limit. When it comes to the tax payer’s determination for deductibility of the contribution, it is only when the tax payer is participating in an employer’s plan will their income will affect the deductibility. Even if their contribution is not deductible, they may still make the contribution. They will just need to track their nondeductible contribution using an IRS Form 8606.
- For Roth IRAs, there is no age limit.
- Earned income is required for making a contribution.
- Lastly, there is an income limit in determining their eligibility to make a contribution. IRS Publication 590-A would be a good reference for the taxpayer to brush up on the rules.
Remember, you still have time to open a self-directed IRA and contribute before the tax deadline of April 18th, 2017, but you must act soon! Contact us today to get started.