Age and Income Are Determining Factors for Traditional IRA Contributions
By Jodie Norquist
EDITOR’S NOTE: On December 20, 2019, the President signed into law the Further Consolidated Appropriations Act, 2020, which includes the major retirement savings-related provisions of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. Many of the provisions became effective January 1, 2020, including one that removes the age 70½ limitation for making Traditional IRA contributions. Beginning in 2020, individuals must only have earned income to contribute to a Traditional IRA. Other SECURE Act provisions affect what is considered earned income for IRA contribution purposes. Effective January 1, 2020, “difficulty of care” payments and certain stipend, fellowship, and similar payments to graduate and postdoctoral students qualify as eligible compensation to meet the earned income requirement.
For your clients who are looking for another way to save for retirement outside of work, a Traditional IRA is a tax-advantaged option for many working individuals to grow pretax retirement savings, even if they already contribute to an employer-sponsored retirement plan. The pretax assets remain tax-deferred until withdrawn from the IRA. But not everyone is eligible for Traditional IRA contributions.
Traditional IRA Eligibility
Individuals must meet two primary eligibility requirements for Traditional IRA contributions.
1. They must not be age 70½ or older.
2. They must have earned income.
Earned Income
Eligible compensation (generally earned income) must have been earned during the year for which the individual is making the contribution. Earned income includes wages, salaries, tips, professional fees, bonuses, and other income-generating streams received from working. Commissions, self-employment income, nontaxable combat pay, and military differential pay also are eligible compensation.
Income that is not considered eligible compensation to fund an IRA includes earnings and profits from property and investments, such as rental income, interest income, and dividend income. Any foreign earned income, other than combat pay, also is not eligible compensation, nor are Social Security, pension, annuity, and any other retirement income.
Individuals can rely on the amount shown in the “Wages, tips, other compensation” box, reduced by the amount in the “Nonqualified plans” box, of their Form W-2, Wage and Tax Statement, as eligible compensation, according to IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs). But non-W-2 income from services legitimately rendered qualifies too.
Age Limitation
Individuals must be under age 70½ to contribute to a Traditional IRA. So if they turn 70½ in 2020, they may not make contributions for 2020. However, they could make a prior-year contribution for 2019 if they had earned income in 2019; the contribution deadline would be their 2019 tax return due date (April 15, 2020, for most taxpayers), not including extensions.
Contribution Limits
The IRS restricts the amount that IRA owners can contribute to IRAs in any given year, and these limits are subject to cost-of-living adjustments. For 2019 and for 2020, eligible individuals can contribute a maximum of 100 percent of their earned income up to $6,000, plus a $1,000 catch-up contribution if they turn age 50 or older in the year for which the contribution is made. Those who are married filing a joint tax return can consider their spouse’s income too. This allows married couples to contribute the maximum amount for each of them, assuming they have enough earned income to support both contributions. The contribution limit applies to each individual for all of their Traditional and Roth IRA contributions, in aggregate.
Traditional IRA Deduction Eligibility
Many choose to contribute to a Traditional IRA to receive a federal income tax deduction. Whether they qualify for a deduction depends on their retirement plan participation status and the amount of their income.
Those who make or receive contributions to their employer-sponsored retirement plan accounts or are eligible to earn retirement credits in a retirement (generally pension) plan for an applicable year are considered active participants. Active participation is shown in Box 13 on an individual’s Form W-2. Some exceptions are described in IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).
If an IRA owner is not an active participant in a retirement plan, and is not married to an active participant, he may take a federal income tax deduction of his entire Traditional IRA contribution. But for active participants—either self, or a spouse of—deduction eligibility is contingent on their modified adjusted gross income (MAGI) and federal income tax filing status. The MAGI limits used to determine the deductibility of Traditional IRA contributions for active participants are summarized below.
As shown in the phase-out ranges in the table above, an IRA owner whose MAGI is less than or equal to the lower threshold (e.g., single active participant with 2019 MAGI of $64,000 or less) can deduct her entire Traditional IRA contribution. If an owner’s MAGI is equal to or exceeds the higher threshold (e.g., single active participant with 2019 MAGI of $74,000 or more), none of her Traditional IRA contribution for the year is deductible. If an owner’s MAGI is within the phase-out range, some, but not all, of her Traditional IRA contribution is deductible, based on a pro rata formula. Individuals can calculate this using the “Figuring Your Modified AGI” worksheet in IRS Publication 590-A.
Those who do not qualify for a deduction can make nondeductible contributions to a Traditional IRA; even those who qualify are not required to claim a deduction for their contributions. If making Traditional IRA nondeductible contributions, individuals must file Form 8606, Nondeductible IRAs, with their income tax returns.
Contribution Eligibility vs. Deductibility
Be careful not to confuse Traditional IRA contribution eligibility with deduction eligibility. Your clients may tend to think of them as one in the same, but it’s important to point out the key differences.
Although IRA owners are responsible for determining both their IRA contribution eligibility and their Traditional IRA deduction eligibility, your financial organization may have resources to help, such as IRA contribution eligibility forms. IRA owners should also seek competent tax advice.
