It is that time of year to consider making an IRA contribution.  You have until April 18, 2023 to make a contribution for 2022.  You can also make your 2023 contribution at the same time. 

You’ve probably heard the following before, but it is true!

  • Tax-deferral allows your investment to grow faster;
  • Achieve even greater tax benefits if you qualify for a tax deduction or tax-free growth;
  • Start early to give your money more opportunity to grow.
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Here are the details…

Contribution Limit & Timing – For 2022, you can make an annual IRA contribution up to $6,000 or 100% of earned income, whichever is less.  The maximum contribution increases to $6500 for 2023.  If you are at least age 50 and have more earned income, you can also contribute an extra $1,000 (called a “catch-up”).  Earned income is employment income, including self-employment income, but only to the extent it is taxable.  It does not include rental income, interest, dividends, capital gains, disability payments, social security payments, pension, annuity, or deferred compensation payments; however, it does include taxable alimony (alimony agreements signed in 2019 and beyond are probably not taxable).  Non-working spouses are also eligible to make contributions based on the working spouse’s income.  You can make an IRA contribution any time during the year and have up until the tax deadline in the following year, which is generally April 15th (unless the IRS give an extra day or two because the 15th is on a weekend), but there are no extensions, even if you get an extension to file your income taxes.

Traditional IRA – Contributions are deductible, but only if neither you nor your spouse is a participant in a qualified company retirement plan, such as a 401k or Profit Sharing Plan.  If you are a participant in a qualified plan, then your ability to deduct a Traditional IRA contribution for 2022 begins to phase-out at $68,000 Adjusted Gross Income (AGI) if you are single or $109,000 if you are married.  Your spouse’s ability to deduct a contribution begins to phase-out at $204,000 if only you are a participant in the qualified plan.  The 2023 AGI limits are slightly higher.  Due to a law change in 2020, anyone with earned income is eligible to make a Traditional IRA contribution even those subject to the required minimum distribution (RMD) rules. Distributions are generally taxable, subject to a 10% early withdrawal penalty prior to age 59½. You must take a Required Minimum Distribution (RMD) at a certain age and the current rules are as follows:

  • Age 72 (formerly age 70 1/2) – Born 1950 or earlier
  • Age 73 – Born 1951 – 1959
  • Age 75 – Born 1960 or later

Roth IRA – Contributions are never deductible, but distributions are generally tax-free.  Participating in a qualified plan does not affect your ability to contribute to a Roth IRA; however, your ability to make a 2022 contribution begins to phase-out at $129,000 AGI for single taxpayers and $204,000 for married taxpayers.  Again, the 2023 AGI limits are slightly higher. RMDs don’t apply to Roth IRAs, but the earnings portion of distributions may be taxable and/or subject to a 10% penalty if the Roth IRA was not opened for 5 years depending on your age (there are different rules for those under 59½ and those over 59½).

Roth IRA Conversion – It is also possible to convert a Traditional IRA to a Roth IRA.  The amount converted is considered a taxable event in the year of the conversion and is likely subject to both federal and state income taxes.  Basically, converting means you want to pay taxes now to avoid taxes later.  This provides the most tax advantage if your future tax bracket will be higher than your current tax bracket, especially when you will be taking distributions from your Traditional IRA.  As such, a comparison of your current income and tax rate against your estimated future income and tax rate is critical to determining whether converting will provide you with a tax advantage.  Spreading your conversion over a multi-year period is also possible and often advisable.

In limited circumstances, it may be possible to make a non-deductible Traditional IRA contribution and then convert to a Roth IRA without any tax (this is often referred to as a “backdoor” Roth IRA contribution).

Employer Retirement Plans – You should also consider participating in your employer’s retirement plan (if any), especially if it offers an employer matching contribution – that’s free money!  If you own your own business, you should consider creating your own retirement plan.  There are a few types that can be used so an analysis of your situation is needed to put the best plan in place for your business.  Overall, you may be able to contribute a lot more into an employer retirement plan than you can contribute into a Traditional IRA or Roth IRA.

Of course, I am happy to analyze your situation and/or coordinate with your accountant in order to help maximize your tax-deferred savings.  Call Andrew Novick, CFP, JD at The Investment Connection 908-595-2220.