As you may or not know, many aspects of the tax code are subject to certain phaseouts – IRA contributions, medical expenses, rental real estate losses to name a few.  However, there are ways to combat these phaseouts and still accomplish what you want to.   For some of the aforementioned phaseout items, the rules can get pretty complex given different scenarios so I’ll stick to the basics and tackle different items over the coming weeks.

Retirement contributions

If your goal is to contribute to a retirement plan and you choose an IRA as your retirement savings vehicle, then you may have certain income limitations before you can no longer make a deductible contributions.   If you are filing alone – single, head of household, or qualifying widow(er) – and are NOT covered by a retirement plan at work, then you can earn any amount and still receive a full deduction of your IRA contribution.   However, if you are Married Filing Jointly or Separately, this is where you may be limited.  If your spouse is NOT covered by a plan then your AGI can be whatever it wants to be and still receive a deduction for your IRA contribution.   However, if your spouse IS covered by a plan at work, then your AGI is limited to $193,000 or less to receive a deduction for a full IRA contribution ($193,000-$203,000 is eligible for a partial deduction).

An example of this would be if the higher earning spouse contributes to their 401(k) and makes > $193,000 and the lower earning spouse doesn’t participate in their employer’s retirement plan (or their employer doesn’t offer one).   There are a couple of ways to combat this to #AvoidThePhaseout – 1) contribute if the employer offers a plan.  In many cases they’ll offer a match, which is FREE money; 2) suggest that your employer offer a plan.  There are many plans that have little to no fees, which is usually the reason a business doesn’t offer one; or 3) still contribute to the IRA but understand that it won’t be deductible.

After reading that last sentence, you might be thinking “They why even contribute to one?!” and I’m glad you asked.   When you contribute to a traditional, deductible IRA, you are receiving a tax benefit in the year of contribution, therefore you are taxed when you withdraw the money.   If you ONLY make non-deductible contributions, you’ll have received no tax benefit up front therefore there is no tax upon distribution.   (If you have a combination of deductible AND non-deductible contributions, you are taxed on the ratio of non-deductible contributions to FMV of your total IRA balance(s).)  We see this often when one spouse earns good money and contributes to an employer plan (401(k), SIMPLE, etc.) and the other spouse works in the home.  Even though the non-working spouse has no earned income, they are still able to contribute to an IRA.  If they never work, therefore not accumulating any pre-tax retirement contributions, then this will serve as an excellent retirement savings vehicle w/ tax-free growth.

The real limit comes into play if you are Married Filing Separately.  For this filing status your AGI is limited to $10,000 to receive only a partial deduction.

There are many benefits to the Roth IRA – tax free growth and no Minimum Required Distribution upon reaching age 70 1/2, to name 2 – but they are also subject to similar income phase-out limitations – $193,000 – $203,000 when filing jointly.   One strategy to #AvoidThePhaseout is to contribute to a non-deductible, traditional IRA, as discussed above, then convert those dollars to a Roth IRA.   This used to be limited to AGIs under $100,000 but is now open to any AGI level.   The tax-ability of it is similar to that of an IRA distribution that includes both deductible and non-deductible contributions.  However, if a taxpayer has no deductible, traditional IRA contributions, the full amount of the conversion would not be taxed since there was no benefit received initially.

Check back in the coming weeks for discussions on other ways to #AvoidThePhaseout.   In the meantime, if you have any questions, please feel free to reach out.