Tax savings opportunities during the 2013 IRA season

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The IRA season, from January 1 through April 15, may offer you opportunities to cut taxes and enhance your estate planning. In this article, TIAA-CREF wealth planners Doug Rothermich, JD and John O’Shea, JD answer frequently asked questions on IRAs and share their thoughts regarding the current IRA season.

  1. Why do many financial providers, like TIAA-CREF, emphasize IRAs each year beginning in January?
    Most people begin to receive their important income tax papers (e.g., W-2 and 1099 forms), in January and, as a result, start to think about ways of reducing the amount of federal, and possibly state, income tax owed on or before the IRS tax filing deadline of April 15. With that in mind, most taxpayers can receive an up-front income tax deduction on contributions to a Traditional IRA. You can contribute up to $5,000 ($6,000 if age 50 or over) of earned income for 2012. You can contribute up to $5,500 ($6,500 if age 50 or over) of earned income for 2013. If you have not previously made your 2012 contribution, then during the time frame of January 1 through April 15, you can contribute for both 2012 and 2013 — a total of $10,500 ($12,500 if age 50 or over). Any earnings from your contributions grow on a tax-deferred basis until you tap into those funds in retirement.

  2. Are you saying that I can contribute to a Traditional IRA in 2013 and deduct the amount against 2012 income?
    Yes. If you contribute to a Traditional IRA between January 1 and April 15, you have the option of treating the amount as a contribution for 2012 or 2013. If you don’t specify which year, the financial provider typically reports the contribution for the current year.

  3. What if I already filed my income tax return (e.g., in February), then learn about this strategy later, and decide to make an IRA contribution in March for the previous year?
    You can still treat it as a 2012 contribution as long as you contribute by the due date of the federal income tax return (April 15 in 2013), not including extensions. In this case, you would file an amended 2012 federal income tax return to claim the deduction and request a refund, if applicable.

  4. How does the up-front income tax deduction work?
    Anyone with earned income who is under age 70½ is eligible to contribute to a Traditional IRA, but the question is whether you can deduct the contributed amount against taxable income. The rules for deductibility vary, depending upon your marital status and income level, referred to as adjusted gross income (AGI).


  5. What if my AGI is above the threshold for receiving an income tax deduction?
    You can still contribute up to $5,500 each year to a Traditional IRA ($6,500 if age 50 or over). There are two benefits to this strategy. First, even though the initial contribution is not tax deductible, the investment earnings can still accumulate tax deferred until withdrawal. Second, the IRA typically has some creditor protection attributes at the federal and at most state levels, making it particularly attractive to physicians and other professionals who are at a higher risk for professional liability.

Another option is to explore the merits of a Roth IRA. The Roth IRA uses an AGI threshold for who is eligible to contribute that is substantially higher than what applies for eligibility for tax deduction with a Traditional IRA. (See table below.) Roth IRA contributions can be made at any age, even after age 70½. And, the contribution amount is the same as with a Traditional IRA — $5,500 ($6,500 if age 50 or over). The difference is that the contribution to the Roth IRA is not deductible against income tax. But, the advantages are that the earnings compound tax free, rather than tax deferred, and the Roth IRA is not subject to the required minimum distribution rules, which means that the assets can compound tax free for life — if not needed for support.

Rules for contributing to a Roth IRA

 
Marital statusSingle individualMarried couple

Ability to contribute up to $5,000 ($6,000 if 50 or older) for 2012.

Ability to contribute up to $5,500 ($6,500 if 50 or older) for 2013.

For 2012, contribute the full amount if AGI is $110,000 or less. Make a partial contribution if AGI is between $110,000 and $125,000.

If AGI exceeds $125,000, consider making a nondeductible contribution to a Traditional
IRA, and then possibly convert that amount into a Roth IRA. When calculating the taxable and nontaxable amounts of a converted IRA, you must consider the taxable and nontaxable amounts inside all of your IRAs (not just the converted IRA). And, the allocation is made on a pro rata basis. This means that you do not benefit from choosing the IRA with the most nondeductible contributions to convert.

For 2013, contribute the full amount if AGI is $112,000 or less. Make a partial contribution if AGI is between $112,000 and $127,000.

If AGI exceeds $127,000, consider making a nondeductible contribution to a Traditional
IRA, and then possibly convert that amount into a Roth IRA. When calculating the taxable and nontaxable amounts of a converted IRA, you must consider the taxable and nontaxable amounts inside all of your IRAs (not just the converted IRA). And, the allocation is made on a pro rata basis. This means that you do not benefit from choosing the IRA with the most nondeductible contributions to convert.

For 2012, contribute the full amount if you and your spouse’s combined AGI is $173,000 or less. Make a partial contribution if you and your spouse’s AGI is between $173,000 and $183,000.

If AGI exceeds $183,000, consider making a nondeductible contribution to a Traditional
IRA, and then possibly convert that amount into a Roth IRA. When calculating the taxable and nontaxable amounts of a converted IRA, you must consider the taxable and nontaxable amounts inside all of your IRAs (not just the converted IRA). And, the allocation is made on a pro rata basis. This means that you do not benefit from choosing the IRA with the most nondeductible contributions to convert.

For 2013, contribute the full amount if you and your spouse’s combined AGI is $178,000 or less. Make a partial contribution if you and your spouse’s AGI is between $178,000 and $188,000.

If AGI exceeds $188,000, consider making a nondeductible contribution to a Traditional
IRA, and then possibly convert that amount into a Roth IRA. When calculating the taxable and nontaxable amounts of a converted IRA, you must consider the taxable and nontaxable amounts inside all of your IRAs (not just the converted IRA).
And, the allocation is made on a pro rata basis. This means that you do not benefit from choosing the IRA with the most nondeductible contributions to convert.

Rules for Traditional IRA tax deductibility

 
Marital statusSingle individual or head of household
(who doesn’t participate in any employer-sponsored retirement plan)
Single individual or head of household
(who participates in an employer sponsored retirement plan)
Married filing separately
(one spouse participates in an employer-sponsored retirement plan)

Potential tax deduction on a contribution of up to $5,000 on a Traditional IRA ($6,000 if age 50 or over) for 2012.

Potential tax deduction on a contribution of up to $5,500 on a Traditional IRA ($6,500 if age 50 or over) for 2013.

Deduct the full amount from income as long as the earned income is at least equal to the contributed amount.

For 2012, deduct the full amount from income as long as (A) earned income is at least equal to the contributed amount, and (B) the AGI for the tax year is $58,000 or less. Deduct a partial amount if AGI is between $58,000 and $68,000.

For 2013, deduct the full amount from income as long as (A) earned income is at least equal to the contributed amount, and (B) the AGI for the tax year is $59,000 or less. Deduct a partial amount if AGI is between $59,000 and $69,000.

For both 2012 and 2013, deduct a partial amount from income if you and your spouse’s combined AGI is less than $10,000.
Marital statusMarried filing jointly
(neither spouse participates in an employer-sponsored retirement plan)
Married filing jointly
(both spouses participate in an employer-sponsored retirement plan)
Married filing jointly
(one spouse participates in an employer-sponsored retirement plan)

Potential tax deduction on a contribution of up to $5,000 on a Traditional IRA ($6,000 if age 50 or over) for 2012.

Potential tax deduction on a contribution of up to $5,500 on a Traditional IRA ($6,500 if age 50 or over) for 2013.

For both 2012 and 2013, deduct the full amount from income for each (a combined $11,000 to $13,000) regardless of combined AGI.

For 2012, deduct the full amount from income for each (a combined $10,000 to $12,000) as long as (A) you and your spouse’s combined earned income is at least equal to the contributed amount, and (B) you and your spouse’s AGI for the tax year is $92,000 or less. Deduct a partial amount if you and your spouse’s AGI is between $92,000 and $112,000.

For 2013, deduct the full amount from income for each (a combined $10,000 to $12,000) as long as (A) you and your spouse’s combined earned income is at least equal to the contributed amount, and (B) you and your spouse’s AGI for the tax year is $95,000 or less. Deduct a partial amount if you and your spouse’s AGI is between $95,000 and $115,000.

For 2012, deduct from income the participating spouse’s contribution as long as (A) you and your spouse’s combined earned income is at least equal to the contributed amount, and (B) you and your spouse’s AGI for the tax year is $92,000 or less. Deduct a partial amount if you and your spouse’s AGI is between $92,000 and $112,000.

For 2012, deduct from income the nonparticipating spouse’s contribution as long as you and your spouse’s combined AGI does not exceed $173,000. Deduct a partial amount if you and your spouse’s AGI is between $173,000 and $183,000.

For 2013, deduct from income the participating spouse’s contribution as long as (A) you and your spouse’s combined earned income is at least equal to the contributed amount, and (B) you and your spouse’s AGI for the tax year is $95,000 or less. Deduct a partial amount if you and your spouse’s AGI is between $95,000 and $115,000.

For 2013, deduct from income the nonparticipating spouse’s contribution as long as you and your spouse’s combined AGI does not exceed $178,000. Deduct a partial amount if you and your spouse’s AGI is between $178,000 and $188,000.

The power of tax-deferred compounding in a Traditional IRA

If you’re able to regularly contribute to a Traditional IRA and are eligible to deduct the contributed amount, it can be a powerful supplement to other retirement benefits.

Take a hypothetical example of Arthur (age 40), who maximizes his annual contribution to his Traditional IRA for 25 years to supplement his retirement income. He receives an annualized return of 5%. His highest federal marginal income tax bracket is 25%, and his highest marginal state income tax bracket is 5%. The table below combines the federal and state tax rates to estimate Arthur’s annual and total tax savings. If tax rates should increase, his annual and total tax savings would also increase, making his tax strategy even more desirable.

 
Arthur’s AgeIRA AmountIRA
Contribution
IRA BalanceAnnual
Tax Savings
Total
Tax Savings
40$5,500$5,775$1,733$1,733
41$5,775$5,500$11,839$1,733$3,465
42$11,839$5,500$18,206$1,733$5,198
43$18,206$5,500$24,891$1,733$6,930
44$24,891$5,500$31,911$1,733$8,663
45$31,911$5,500$39,281$1,733$10,395
46$39,281$5,500$47,020$1,733$12,128
47$47,020$5,500$55,146$1,733$13,860
48$55,146$5,500$63,678$1,733$15,593
49$63,678$5,500$72,637$1,733$17,325
50$72,637$6,500$83,094$1,950$19,275
51$83,094$6,500$94,074$1,950$21,225
52$94,074$6,500$105,603$1,950$23,175
53$105,603$6,500$117,708$1,950$25,125
54$117,708$6,500$130,418$1,950$27,075
55$130,418$6,500$143,764$1,950$29,025
56$143,764$6,500$157,777$1,950$30,975
57$157,777$6,500$172,491$1,950$32,925
58$172,491$6,500$187,941$1,950$34,875
59$187,941$6,500$204,163$1,950$36,825
60$204,163$6,500$221,196$1,950$38,775
61$221,196$6,500$239,081$1,950$40,725
62$239,081$6,500$257,860$1,950$42,675
63$257,860$6,500$277,578$1,950$44,625
64$277,578$6,500$298,281$1,950$46,575
65$298,281$6,500$320,021$1,950$48,525
Totals$159,000

The above is based on hypothetical assumptions and not intended to represent the performance of any specific investment company product. It cannot predict or project investment returns. The IRA balances and the tax savings balances are pre-tax. Any withdrawal is subject to federal (and possibly) state income tax for the distribution year.

Contribute to someone else’s IRA as a gift

Why would I want to contribute to an IRA as a gift, and how would I go about doing that?

If you want to help a friend or family member, such as a child or grandchild, who may not be able to save for retirement, you can gift to that person the amount needed so that he or she can contribute to an IRA each year. The friend or family member can contribute to an IRA each year as long as he or she has earned income at least equal to the gifted amount. For example, you could make a gift/contribution for a teenager with summer employment, a college student working part time, a young adult just entering the full-time workforce who is trying to pay off student loans, or more established adults who are employed but have not been able to adequately save for their retirement.

Under the federal gift rules, you can gift up to $14,000 in 2013 to any person without reporting the gift amount to the Internal Revenue Service, but the IRA contribution rules limit you to $5,500 per person ($6,500 if age 50 or over).

This IRA gift provides you with a way to teach the individual about investing and to discuss their comfort level with dealing with market fluctuations and the merits of diversifying the IRA investment portfolio in different asset classes, such as stocks, bonds and real estate. This educational process is especially important if this person will eventually serve as your agent under a Durable Power of Attorney, or if this person will inherit a larger, more substantial amount, upon your death.

As an added bonus, Traditional IRAs and Roth IRAs have broad creditor protection under federal and most state laws, which can be beneficial to a younger loved one who has professional liability concerns, a bad marriage or other creditor issues.

Best of all, you can open a low-cost TIAA-CREF Traditional IRA or Roth IRA product for a family member, which then qualifies the family member to receive our advice services at no additional cost.

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