Individual Retirement Accounts (IRAs) 

An IRA is a tax-deferred savings plan available to anyone who is employed or who receives alimony. IRA contributions are saved in a special account at a financial institution, which serves as the custodian or trustee. Most people are eligible to deduct their total IRA contributions from their income taxes. With an ordinary (traditional) IRA all or some of the contributions and all of the earnings grow tax-free until withdrawal. Those who earn too much to make deductible contributions can protect earnings from taxation by opening a Roth IRA (or if income is even higher by opening a nondeductible IRA). With a Roth IRA, contributions are not deductible, but earnings are tax-free if certain conditions are met. With a nondeductible IRA, contributions are not deductible but the earnings grow tax-free until withdrawal (similar in part to that of an annuity).

Traditional IRA contributions may or may not be deductible, depending on your income level, your tax filing status, and whether you use a qualified retirement plan (of which there are several, see the other retirement planning tabs of this site). Traditional IRA accounts grow tax-deferred until you begin withdrawing the money.

For 2020 and 2021, you may fully deduct up to $6,000 in IRA contributions, regardless of your income level, unless you (or your spouse) are covered by an employer-sponsored retirement plan. In addition, $1,000 additional catch-up contributions may also be made if you are age 50 or over, for a total of $7,000 annually for 2020 (and 2021). Even if only one of the couple has earnings, contributions may be made up to these amounts, meaning up to $14,000 may be contributed on behalf of the couple (limited to the total earnings of that person).

In 2020, for taxpayers who are married filing jointly, with both individuals active participants in a retirement plan (basically any type), only if AGI reaches $104,000 does this deductible amount proportionately decrease – (maxing out at an AGI of $124,000).

Greater than $124,000, no current deduction is allowed, but a non-deductible portion may be made for the year (but cannot in total, exceed the overall IRA deduction limits of $6,000 to $7,000) – however, a Roth IRA deduction for that non-deductible portion may be a better option (since Roth IRA phaseouts occur between $196,000 and $206,000, and funds may be withdrawn with fewer restrictions).

For single status filers, 2020 IRA contributions are similarly reduced at AGI between $65,000 and $75,000.

Also, one will not be considered an active participant in an employer-sponsored plan simply because one’s spouse is treated as an active participant. Furthermore, if an individual who is not an active participant, is married to one who actively participates in a retirement plan, that person may also make a deductible contribution (i.e., even if one of them was not employed) as long as the couple’s total 2020 modified AGI is less than $196,000 (phasing out at the $206,000 limit). 

Note: You may also effect a backdoor contribution to a Roth IRA, by contributing to a non-deductible IRA, and then immediately converting that contribution to a Roth (since there is no income limit phasing out the contribution amount in traditional IRA).

Please note: the deadline for contributions is April 15th following the tax year end. There is no extension for the contribution! (same rule applies to Roth IRA’s – and for SEP’s – see tab: “Simplified Employee Pension Plan”) this includes extension date of October 15). Ideally, one should contribute to an IRA as early in the tax year as possible. This allows the account to earn the greatest return by getting an early start. However, you can make contributions throughout the year and as mentioned, even up until April 15th of the following year. (Be careful, if you’ve delayed making a contribution for the prior year by waiting until after year end, you may need to submit a written statement to the custodian of your IRA indicating that the contribution is for the preceding year, otherwise the contribution will be applied to the year during which it is made).

Regardless, you can generally contribute to an IRA even if you are otherwise precluded from deducting it. The earnings on the account remain tax-deferred until the funds are ultimately withdrawn upon retirement or passed on to heirs. This is in substance similar to an annuity, where the earnings accumulate tax-free until you withdraw the funds. The key difference is the protection often afforded these retirement accounts from creditors’ claims.

If you are covered by an employer-sponsored plan, you may still contribute the maximum amounts mentioned above, which allows your contributions to grow tax-free (again, similar to an annuity) until withdrawn. All contributions are fully taxed when withdrawn – earnings and any untaxed contributions are taxed as ordinary income at your highest “marginal” tax rate when you take withdrawals upon retirement (or earlier generally with penalties). You may begin these retirement distributions when you are age 59½ during the tax year. You must, by law, start to take regular IRA withdrawals no later than the year after you turn age 70½ (based on your life expectancy factor).

If you withdraw money from an IRA before retirement age, you will probably pay taxes plus a 10% penalty. You can avoid this penalty in certain situations. There are exceptions to the 10% penalty as follows: Death of the IRA owner, disability, periodic payments, certain medical expenses, qualified higher education expenses, and a qualified first-time home purchase.

A spousal IRA is for an individual (married filing jointly) with little or no earned income and no retirement plan at work. One may also contribute up to $6,000 (or up to $7,000 each with catch-up contributions, when 50 yrs. old by year-end) to IRAs for both the earner and spouse (and so: $12,000 total, or $14,000 with catch-ups) as long as this amount is not more than total earnings for the year. The spouse using a spousal IRA may deduct these contributions, up to $6,000 per year, even if the earner does not have a retirement plan at work.

Again, for 2020, even if the working individual on a jointly filed return has an employer retirement plan, the non-working spouse’s IRA deduction (of up to $6,000 — $7,000 if over 50 yrs. old) is not phased out until joint AGI is between $196,000 and $206,000. The rules are varied, and contribution amounts may be limited. I would be glad to discuss these rules with you if you have any questions.