The IRS recently
issued IRS Tax Tip 2017-29 for Individual Retirement Accounts (IRA) for the 2016 tax year. This post reviews some of the tips and offers
a few others.
1.
Age Rules. Taxpayers must be under age 70½ at the end of
the tax year to contribute to a traditional IRA. There is no age limit to contribute to a Roth
IRA (or to contribute to a SEP-IRA or a SIMPLE-IRA).
2.
Compensation Rules. A taxpayer must have taxable
compensation to contribute to an IRA. This includes income from wages and
salaries and net self-employment income. It also includes tips, commissions, bonuses
and alimony. If a taxpayer is married
and files a joint tax return, only one spouse needs to have compensation.
3.
When to Contribute. Taxpayers may contribute to an
IRA at any time during the year. To
count for 2016, a person must contribute by the due date of their tax return, not
including extensions. This means you
must contribute by April 18, 2017. Taxpayers
who contribute between January 1 and April 18 need to advise the plan sponsor
of the year they wish to apply the contribution (2016 or 2017). From a financial planning perspective, you
should contribute at the start of each calendar year. That way your contribution has a 15 ½ month
head start in earning money before the contribution deadline. For example, contributing $5,500 over 30
years at a 6% rate of return at the beginning of the year (instead of at the
end of the year) will result in a $31,000 higher IRA balance.
4.
Contribution Limits. Generally, the most a taxpayer
can contribute to their IRA for 2016 is the smaller of either their taxable
compensation for the year or $5,500. If
the taxpayer is 50 or older at the end of 2016, the maximum amount they may
contribute increases to $6,500. However,
the ability to contribute to a Roth IRA phases out at certain AGI levels. If a person contributes more than these
limits, a 6% annual penalty will apply to the excess until corrected.
5.
Deductibility Rules. Taxpayers may be able to deduct
some or all of their contributions to their traditional IRA. These rules are complex and will depend upon
your personal tax situation. See IRS
Information Release IR-2017-60
for more details.
6.
Taxability Rules. Normally taxpayers don’t pay
income tax on funds in a traditional IRA until they start taking distributions
from it. Qualified distributions from a
Roth IRA are tax-free. Unless an
exception applies, distributions prior to age 59 ½ will incur a 10% penalty.
7.
Required Minimum Distributions (RMD). Individuals
who are age 70 ½ or older must take a RMD from their traditional IRA (but not from a Roth IRA) by December 31st of each calendar year to avoid a 50%
penalty on any required amount that was not received. For the calendar a person turns age 70 ½,
they may defer the first RMD to April 1st of the following
year. For those turning age 70 ½ in
2016, the RMD must be received by April 1, 2017, even though that date falls on
a Saturday. There is no weekend rule
that would enable receipt on Monday, April 3, 2017, to be considered
timely. If you chose to delay your 2016
RMD until April 1, 2017, your 2017 RMD must be received by December 31, 2017,
which results in the doubling up of distributions. For guidance on calculating the RMD see IRS
Information Release IR-2017-63. For charitably minded individuals, a qualified
charitable distribution from a traditional IRA will count towards satisfying
your RMD.
