Still Time to Make an IRA Contribution
March 29, 2010
If you have not done so already, you still have time to contribute to an IRA for tax year 2009. If you have been told not to bother, because your contribution would not be tax deductible, please read this article. There are real benefits to making a non-deductible contribution.
April 15, 2010, is the deadline for making a contribution to an IRA for 2009. This is also the initial deadline for filing your income taxes. You can request an extension to push your filing deadline to later in the year, but your contribution to an IRA must still be made by April 15.
Contribution Amount
You can only contribute to an IRA if you have “earned” income generated by working for yourself or an employer. Unfortunately, investment income, such as dividends, interest, and capital gains, does not qualify as earned income.
For 2009, the maximum that you can contribute to an IRA is $5,000, as long as you earned at least $5,000 during the year. If you earned less, for example $2,600, you can only contribute up to that amount. For married couples, both can qualify for an IRA even if only one has earned income. For anyone over age 50, an additional $1,000 can be contributed, bringing the maximum to $6,000. The same amounts apply to tax year 2010. And, by the way, you are eligible to contribute to an IRA for tax year 2010 as early as January 1, 2010.
Deductible or Non-deductible IRA?
If you are not covered by a retirement plan at work, any contribution that you make to a traditional IRA will be deductible on your tax return.
If you do have a 401(k), pension, or other retirement plan available to you through your employer, an IRA contribution will not be deductible if modified adjusted gross income (MAGI) on a joint return exceeds $109,000 ($66,000 for single filers).
Should I contribute if my contribution is not tax deductible? YES
Yes. If you have maximized your pre-tax contributions to your company retirement plan and still have funds to invest for your future retirement, a non-deductible contribution to your IRA can still provide benefits. There are two solid reasons why:
First, you may be eligible to contribute to a Roth IRA. If you are a joint filer and your MAGI is less than $177,000 ($120,000 for single filers), you are eligible to contribute to a Roth IRA. The contribution to a Roth IRA is non-deductible, but any earnings will be tax-free after the account is in existence for five years and you are over age 59 ½ years. If you qualify, this is your best option.
If you do not qualify for a Roth IRA, then your only alternative is to make a non-deductible contribution to a traditional IRA. The benefit is the deferral each year of any tax on the earnings until the funds are withdrawn after your age of 59½. Deferring taxation is definitely a benefit, especially if your income will be taxed at a lesser tax rate after you retire.
Second, any funds held in a traditional IRA will be eligible for conversion to a Roth IRA. Prior to 2010, only individuals with less than $100,000 adjusted gross income were eligible to convert IRA funds to a Roth IRA. However, beginning with 2010, there are no restrictions, meaning everyone is eligible to convert funds from traditional IRAs to Roth IRAs.
Any non-deductible contributions that you make to your traditional IRA are not taxed when converted to a Roth IRA. In the conversion process, only deductible contributions and earnings are taxed. For example, let’s assume that you have an IRA with a value of $10,000. Of that amount, $6,000 (60%) represents non-deductible contributions and the remaining $4,000 (40%) is attributed to earnings and deductible contributions. If you convert the total IRA to a Roth, of the $10,000 only $4,000 is subject to ordinary income taxation. If you decide to convert only half of the IRA or $5,000, then $2,000 (40%) would be taxable.
The benefit of contributing to a non-deductible IRA is the opportunity that this provides to later move these dollars to a Roth IRA without any tax implications. If your income is too high to allow you to make Roth IRA contributions, the conversion feature is the only opportunity you will have to take advantage of the tax-free earnings of a Roth IRA. Think of your non-deductible IRA as the gateway to a tax-free Roth IRA. You need to fund your IRA to be able to later convert to a Roth IRA. This is why a non-deductible IRA contribution can be a smart move!
Summary
Making an IRA contribution is one more method for accumulating assets to provide financial security throughout your retirement years. Even if the contribution is non-deduction, there is value in deferring the taxation on the earnings and in preserving the opportunity to one day convert the traditional IRA funds to a tax-free Roth IRA.
