By Shawn Glogowski, CFP®
Principal and Chief Compliance Officer
The deadline for 2015 IRA deposits is fast approaching! A Roth IRA or traditional IRA are great ways to put extra money away for your long-term retirement goals. I hear quite a bit of "water cooler talk" from clients and friends who don't know all the moving parts of contributing to an IRA. I thought I would point out a few key facts and try to dispel some myths about investing in IRAs.
Myth 1: If I contribute to my 401k at work, I am not eligible to contribute to an IRA.
- In fact, this is a great way to supplement your savings if you are maxing out your employer sponsored plan. You can put up to $18,000 of salary deferral (for 2015 and 2016) plus contribute $5,500 to a Roth or traditional IRA. Don't forget about the catch-up contributions if you're over age 50—you can put up to $6,000 into your 401k and $1,000 extra into your IRA.
Myth 2: The maximum I can defer to my 401k is a percentage of my pay.
- I know this isn't directly related to contributing to an IRA, but I hear this one a lot. As I mentioned above, the IRS maximum deferral rules state that you can defer 100 percent of eligible compensation per calendar year capped at $18,000 ($24,000 if you're over 50). There, myth dispelled.
Myth 3: I can contribute $5,500 to a Roth AND $5,500 to a traditional IRA
- You want to be sure you don't put $5,500 into both types of IRA accounts. The IRS allows up to $5,500 into one or the other, not both. Keep in mind, you can mix it up if you wish and, for example, put $3,000 into a Roth and $2,500 into a traditional IRA. Just don't go over the $5,500 cap!
Now that we have touched on a few myths, here are some key points you want to pay close attention to when contributing to an IRA.
1. If you exceed the IRS income limit, you are not eligible to contribute.
- Traditional IRAs: if you file a joint tax return and your adjusted gross income (AGI) is under $98,000, you can make a full contribution. Once you get over $118,000, you are not able to deposit any funds into a Traditional IRA.
- Roth IRAs: if you file a joint tax return and your AGI is under $183,000, you can make a full contribution. Once you get over $193,000, you are not able to deposit any funds into a Roth IRA.
- Check out the links below to the IRS website for single and head of household contribution limits:
2. If you have over contributed to an IRA, you have a couple of options.
- You don't want to leave money in an IRA that you were not eligible to contribute to. You will owe a 6% penalty each year you leave the over contributed funds in the account.
- Roth IRA: if you catch it before you file your tax return, you can withdraw the funds. You will be subject to a 10% penalty and taxes on any earnings.
- Traditional IRA: if caught prior to filing a tax return you can withdraw the funds like you can with a Roth, plus a 10% penalty and tax on earnings.
- For either a Roth or traditional IRA, if you catch it after you file your taxes, you can remove the excess funds within 6 months and file an amended return by October 15th.
- If you are under the income phase-out and you over-contribute to an IRA, you can re-characterize your over-contribution you made to the IRA. Check with your IRA custodian for their process of re-characterization.
3. You can only contribute $5,500 in total between traditional and Roth IRA accounts and across multiple custodians (see myth 3 above).
- Simply put, $5,500 is the maximum amount regardless if you have 1 IRA or 5 different IRAs at various custodians.
As you can see, there are a lot of moving parts and rules to follow. There are other things to consider in addition to my points above, so we always recommend to consult your tax and financial advisor when making these decisions. Our hope is this article will at least encourage you to ask yourself and your advisors some important questions before you contribute.