IRA Tax Tips for the 2016 Tax Year

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 31^st 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 1^st 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.