If you earn over a certain amount, the Roth IRA option isn’t available to you, you’re left to go after the Traditional IRA. If you participate in a 401(k), you can’t even deduct the contributions to a Traditional IRA. So, why would anyone ever contribute to a non-deductible Traditional IRA? If you did, you’d be paying taxes on the contributions and taxes on the disbursements when you retire… that’s double taxing and that’s foolish! However, there is one reason why you would want to do this. Conversion!

Right now, only those who earned fewer than $100,000 a year can convert a Traditional IRA to a Roth IRA. However, the Tax Increase Prevention and Reconciliation Act of 2005, signed in May 2006, introduced a conversion loophole in 2010 that removed that $100,000 rule. In 2010, anyone is permitted to convert from a Traditional IRA to a Roth IRA. What this also means is that it gives those above the Roth IRA income phaseout to have a back-door method of contributing to their Roth IRA.

When you convert a Traditional IRA to a Roth IRA, you pay taxes on the sum because you were able to deduct the contributions. If you made contributions to a non-deductible Traditional IRA, you already paid the tax so you can make the conversion absolutely free. That’s the only reason I can see for contributing to a non-deductible Traditional IRA… as long as they don’t close the loophole.

If you’re a stay at home mom or dad, you can make a deductible IRA contribution (or non-deductible if you opt for a Roth) of up to $5,000 for 2008 if you file a joint return and your working partner/spouse has enough earned income to cover the contribution. That’s right, even if you don’t personally earn the income, if you file a joint return than you can contribute to what is known as a spousal IRA.

The rules regarding the Spousal IRA are the same as any other IRA. Your contribution is capped at $5,000 a year, $6,000 if you are older than 50, and you must have the earned income to do it. For example, if you and your spouse want to both contribute the maximum towards your IRAs, your combined earned income must be greater than $10,000 ($5k each). For the purposes of a Roth IRA, the contribution phaseout schedules still apply.

Deductibility Phaseout Rules

The rules start to get a little tricky when you’re talking about deductible IRA contributions and qualified retirement plans (like 401ks). If neither one has a qualified retirement plan, you’re in the clear and can deduct up to $10,000 of contributions. If both participate in a qualified retirement plan, then the phaseout is from $85k to $105k in earned income for deductibility purposes. That means that if your combined AGI is over $105k, then you cannot deduct your Traditional IRA contributions.

If only one participates, then it gets tricky. The deductibility phaseouts for the one participating is the $85k to $105k one listed above. The non-participating spouse instead uses the $159k to $169k phaseout period. For example, if a couple only has one participating member and earns $120k, then the participating spouse can’t deduct contributions but the non-participating spouse can.

Roth IRA

Or you can contribute it all to a Roth IRA, which are after-tax dollars, and then deductibility is not an issue. The phaseouts for the Roth IRA for 2008 are $159k to $169k, meaning if you earn more than $169k then you cannot contribute to a Roth IRA.

Whew!

It’s April 14th, tomorrow is tax filing day, have you made all your contributions for 2007? Now’s your last chance!

IRA Contributions

You have until April 15th of the following year to make contributions for that tax year, so you have until April 15th, 2008 to make your contributions to a 2007 IRA. If you have online account access and a linked bank account, you can still hop online to make your contribution right now. If you have online account access but haven’t linked a bank account, you may not have enough time to go through the verification process, but you are not out of luck. If you mail a check and it’s postmarked before April 15th, you can still get the contribution characterized as a 2007 contribution.

Retirement Savings Tax Credit

You’ll have to file a 1040 or 1040A, or go with an online service like TurboTax that will handle it all for you, but you may qualify for a retirement savings tax credit. The tax credit works on a schedule based on income, with the ceiling being $26,001. If you earn more than $26,001 as a single filer or $52,001 as a married filing jointly then you can skip this paragraph. For everyone else, you can get a credit of up to 50% of your retirement contributions. For single filers, the 50% credit rate is for incomes of less than $15,500, 20% is between that and $17,000, 10% for those earning less than $26,000, and then nothing for anyone over.

Another point to know is that in the case of IRAs, only half of the maximum contribution can be counted towards calculating your credit. So for 2007, the max contribution was $4,000 but only $2,000 figures towards the credit, leaving a maximum credit of $1,000 for single filers.

Almost every recognized retirement account contribution counts from IRAs to 401(k)s to SIMPLES, SEP, 403(b), etc. For additional help, check out Form 8880 Credit for Qualified Retirement Savings Contributions or just use TurboTax.

April 15th is right around the corner and many of you will be making your 2007 IRA contributions right now, that’s great news. Putting money away into a Roth or Traditional IRA is one of the best ways you can save for your retirement, so kudos to you for doing it.

Many brokerages and mutual fund firms are now allowing online ACH transactions and through the menu system you can identify which year the contribution is for. For those who still mail in checks, it’s crucial that you identify the year, which is as simple as putting “2007 IRA Contribution” in the Memo line.

What happens if you forget and your 2007 contribution is listed as a 2008 contribution? What if the brokerage misses the line and puts it into 2008? Not a problem, simply write them a letter and have them “re-characterize” the contribution from a 2008 to a 2007 contribution and you will be okay.

Always double check to see if the brokerage characterized it correctly, you don’t want to discover it next April!

I would’ve listed this particular pitfall higher up on the list, probably behind Not Getting 401K Match, since it’s similar to that pitfall; but this one involves not taking advantage of the various IRAs that may be available to you. Roth IRAs allow you to do some tax-free investing and other IRAs allow you do some tax-deferred investing, either way your principal grows without the burden of tax.

One other considering is that there may come a point when you can’t take advantage of an IRA, the 2007 income phaseouts for the Roth IRA starts at 95k and ends at $110k (single filers).

Source: Yahoo Finance