IRA Contribution Eligibility vs. Deductibility: There Is a Difference
One of the primary reasons individuals contribute to a Traditional IRA is for the tax deduction—something they cannot get with a Roth IRA. And when they aren’t eligible for the tax deduction, they tend to forego the IRA contribution altogether. Often this is because they think not being able to deduct the contribution is the same as not being eligible to contribute. But deduction eligibility is different than contribution eligibility, and Traditional IRA owners who do not qualify for a deduction can benefit in other ways from saving with a Traditional IRA.
As an IRA trustee or custodian, you are not responsible for determining whether an IRA contribution can be deducted, nor are you responsible for tracking Traditional IRA deductions for IRA owners. Both are the IRA owner’s responsibility, and they should see a competent tax advisor for help. But you may be asked to help, so it is important to understand that the two concepts–deduction and contribution eligibility–are separate issues. Knowing how contribution eligibility differs from deductibility when speaking with clients will boost your credibility and the level of customer service you offer.
Before determining whether an IRA owner can deduct a Traditional IRA contribution, the IRA owner first has to be eligible to contribute to a Traditional IRA. The individual must 1) have eligible compensation for the applicable year, and 2) be under age 70½.
Eligible compensation means that an IRA owner (or spouse if filing a joint tax return) must have earned income from services rendered. In addition to wages and salaries, other forms of eligible compensation include commission, self-employment income, and military personnel nontaxable combat pay. The age limit of 70½ means that individuals may no longer contribute to a Traditional IRA beginning with the year in which they attain age 70½.
Eligibility questions generally are addressed on an IRA contribution form, such as Ascensus’ Traditional IRA Contribution Eligibility form, which IRA owners may complete to help determine their eligibility. IRA owners can find more information about eligibility in IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).
Eligible individuals may contribute 100 percent of their eligible compensation up to the statutory maximum amount per year—$5,500 for 2017 and for 2018, plus an additional $1,000 catch-up contribution if age 50 or older. An IRA owner’s Traditional IRA contributions are aggregated with her Roth IRA contributions, if any, for purposes of the annual contribution limit.
Once eligible to make a Traditional IRA contribution, the IRA owner may be able to take a deduction for part or all of the contribution. IRA deduction eligibility is based on three factors.
- Active participation in an employer-sponsored retirement plan
- Tax filing status
- Amount of modified adjusted gross income (MAGI) claimed by the IRA owner
Someone who is participating in or receiving contributions from an employer-sponsored retirement plan is an active participant. Active participation is shown on an individual’s Form W-2, Wage and Tax Statement. The Retirement plan checkbox in Box 13 generally will be checked if he is an active participant in any of the following plans for any part of the year.
- Qualified retirement plans (e.g., pension plan, profit sharing plan, 401(k) plan)
- 403(b) annuity contract or custodial account
- Simplified employee pension (SEP) plan
- Savings incentive match plan for employees of small employers (SIMPLE) IRA plan
- A plan for federal, state, or local government employees or for an agency or instrumentality thereof (not including a 457(b) plan)
Modified Adjusted Gross Income
If an individual is an active participant or is married to an active participant, the deductibility of an IRA contribution depends upon MAGI. MAGI generally is adjusted gross income without taking into consideration the tax deduction for a contribution to a Traditional IRA. Some individuals may have to make other minor adjustments when determining MAGI. Publication 590-A contains a worksheet to help IRA owners determine their MAGI and deductions.
If the MAGI is equal to or below a minimum threshold, the participant is eligible to take a deduction for the full amount of the IRA contribution up to the statutory limit. If an individual’s MAGI exceeds the maximum threshold, no deduction is allowed. If a participant’s MAGI is between the minimum and maximum thresholds (the phase-out range), the IRA owner will have a decreasing amount of deductibility until the maximum qualifying income level is reached.
If one spouse is an active participant in a retirement plan but the other spouse is not, the spouse who is not an active participant must use a different phase-out range to determine her IRA deductibility. The deduction MAGI limits for 2017 and 2018 follow.
If neither the IRA owner nor his spouse is an active participant, all Traditional IRA contributions are deductible, no matter what the income level.
Financial organizations should refer an IRA owner to a competent tax advisor or to the instructions and worksheets in Publication 590-A for assistance. But as a quick reference, the following formula may be used to determine the maximum deduction limit when MAGI falls within the phase-out range.
Even if an individual is eligible for a deduction, she is not required to take the deduction. If choosing not to take the deduction, she will not claim the deduction on her federal tax return, but will instead elect to make a nondeductible IRA contribution by filing IRS Form 8606, Nondeductible IRAs.