Traditional IRAs

The term traditional IRA simply refers to an IRA that is not a Roth IRA, a Coverdell Education Savings Account, a SEP IRA, or a SIMPLE IRA. A traditional IRA can be further classified as either deductible or nondeductible. Furthermore, as shown in Table 1, a traditional IRA also includes a spousal IRA in which a nonworking spouse contributes to his or her IRA. Note that with either a traditional or a Roth IRA, only one spouse needs to have earned income in order for both spouses to contribute in any year to their respective IRAs.

Table 1. Traditional Deductible IRA Versus Traditional Nondeductible IRA Contributions for 2019

Traditional Deductible IRA

Qualification to Make Contributions: Must have earned income; Cannot be older than 70.5 at end of year

Income (MAGI) Limitations: If active participant in employer retirement plan, subject to MAGI* phase-out rules for- MFJ: $103,000-$123,000
Single & HOH: $64,000-$74,000 (No limits for individuals not actively participating in employer retirement plan)

Spousal IRA

Qualification to Make Contributions: A spouse can make contributions based on other spouse’s earned income. Cannot be older than 70.5 at end of year.

Income (MAGI) Limitations: If working spouse is an active participant in an employer plan, the nonworking spouse’s IRA is phased out when MAGI* is between $193,000-$203,000.

Traditional Nondeductible IRA

Qualification to Make Contributions: Individual (or spouse) must have earned income. May not be age 70.5 by the end of the year.

Income (MAGI) Limitations: No limitations

**Modified Adjusted Gross Income (MAGI) = Adjusted Gross Income + Student Loan Interest Deduction + Foreign Earned Income Exclusion + Foreign Housing Exclusion or Deduction + Excluded EE Savings Bond Interest Shown on Form 8815 + Excluded employer-provided adoption benefits shown on Form 8839 + Tuition and Fees Deduction

Whether or not an individual may deduct on their federal and state income taxes (as an adjustment to income) a traditional IRA contribution depends on the following:

  • The individual’s status as an active participant in a qualified retirement plan (all full time and part-time federal employees are considered active participants in a qualified retirement plan) or the employee’s spouse status in an employer-sponsored retirement plan and;
  • The individual’s modified adjusted gross income (MAGI) (see below); and
  • The individual’s filing status.

  MAGI for purposes of determining the deductibility of a traditional IRA contribution is defined as one’s adjusted gross income (which can be determined from the line 8b of the 2019 Form 1040) with the following amounts added back:

  • Student loan interest deduction;
  • Savings bond excluded interest;
  • Foreign earned income and foreign housing exclusions;
  • Tuition and fees deduction

          The MAGI thresholds for deductibility of traditional IRA contributions were changed as part of the Taxpayer Relief Act of 1997. These limits usually increase each year and are shown in Table 2. Federal employees should locate their MAGI in Table 2 for 2019 under the appropriate filing status.

Table 2. “Phase Out” Ranges for Deductible Traditional IRA Contributions Using MAGI

The deduction for an IRA contribution for an individual covered by a pension plan is subject to phase-out at the following 2019 MAGI amounts:
  If married and spouse not covered by pension plan:
 
Married Filing Jointly:  $193,000 and $203,000
  Married Filing Separately: $0 – $10,000  

If married and spouse covered by pension plan:

  Married Filing Jointly: $103,000 to $123,000  
Married Filing Separately: $0 – $10,000  
Filing as Single or Head of Household: $64,000 and $74,000

An individual may have to deduct on 2019 Form 1040 (Schedule 1 Part II, Line 19) (an adjustment to income) less than the maximum possible for a traditional IRA contribution and increase the nondeductible portion correspondingly. Remember that an individual may own as many IRAs (deductible, nondeductible or Roth) as he or she wants; may contribute the maximum allowed to any single IRA for 2019 ($6,000 or $7,000 if age 50 or older); he or she may contribute to all of them provided the total contribution doesn’t exceed the maximum allowed for any year. In the case of a spousal IRA, each spouse determines the deductible amount separately. The deadline for making 2019 IRA contributions is the 2019 individual income tax filing deadline of April 15, 2020, even if an individual files for an extension due October 15, 2020.  

A nondeductible IRA is a traditional IRA in which an individual is unable to deduct (as an adjustment to income) the contribution to the IRA on their federal income tax return. The main reason an individual would not be able to deduct the contribution is that under current rules, an individual cannot take the deduction if they are covered by, or participate in, a qualified retirement plan and their MAGI exceeds certain limits. These limits are shown in Table 2 are for tax year 2019. Note the upper and lower MAGI limits; an individual whose 2019 MAGI falls below the appropriate lower limit would be able to deduct their entire traditional IRA contribution while if their MAGI falls above the appropriate upper limit then no deduction is permitted. An individual whose MAGI is in-between would be able to partially deduct an IRA contribution, as the following example illustrates:

Example.  Julie, age 35, single and works for the federal government, had MAGI of $69,000 during 2019. Julie contributes the maximum allowed of $6,000 to her traditional IRA during 2019. She also participates in the traditional Thrift Savings Plan and is covered by FERS. Since Julie’s MAGI is halfway between the beginning ($64,000) and end ($74,000) of the MAGI “phase out”, she will be able to deduct half ($3,000) of her IRA contribution on her 2019 Federal income tax return. Note: the fact that Julie contributed to the traditional Thrift Savings Plan reduced her MAGI, thereby resulting in her being able to deduct half of her traditional IRA contributions.

The following eight rules apply to a traditional IRA contribution that follows between the full-deduction and no-deduction levels:
  1. The reduction in the deduction applies ratably. For example, a contribution will be 50 percent deductible if the MAGI falls at the midpoint of the range; that is, an individual IRA with a maximum contribution will be deductible in the amount of $3,000 and nondeductible in the amount of $3,000 (for the year 2019 and for someone younger than age 50 as of 12/31/2019).
  2. IRS Publication 590-A (Contributions to Individual Retirement Arrangements) (downloadable from www.irs.gov) has worksheets that allow individuals to compute the deductible portion of an IRA contribution. The portion that is not deductible is considered to be nondeductible.
  3. If any amount remains deductible, $200 is the minimum deductible amount.
  4. In the case of a spousal IRA, the $200 minimum applies to the total deduction on the return. In the case of a joint return in which each spouse is working and contributes to a separate IRA for himself or herself, the $200 minimum applies separately to each.
  5. If the reduction applies so that one spouse has over-deducted (as on an earlier filed joint return) while the other has contributed less than the maximum deductible, no transfer of deduction limit is permitted between the spouses.
  6. A head of household follows the single taxpayer rules for reductions in IRA deductible limits
  7. Qualifying widowers or widows follow the married filing joint taxpayer rules for reductions in IRA deductible limits.
  8. A Section 501(c) (18) plan is considered an employer plan if the taxpayer made deductible contributions during the year. Such a plan, a special type of tax-exempt trust, must have been (a) created before June 25, 1959, and (b) funded only by employee contributions. The deduction limit is reduced by any contributions to such a plan that the taxpayer made during the year.

Nondeductible IRA contributions are always reported on one’s income tax return by filing IRS Form 8606 (Nondeductible IRAs). By not filing Form 8606, the IRS will not have any record of contributions made to one’s IRA that have been previously taxed (because nondeductible IRA contributions have already been taxed, they will not be taxed again upon withdrawal from the IRA). For those years in which Form 8606 was not filed, it can be filed by itself. Unfortunately, there is a penalty for every year it was not filed.

Why would an individual want to make a nondeductible IRA contribution? After all, are there any benefits if one is unable to deduct his or her contributions and get immediate tax relief (similar to TSP contributions)? The answer: tax-deferred growth in the IRA earnings – only the earnings (and not the contributions) will be taxed upon withdrawal. Also, for many individuals whose MAGI exceeds maximum amounts, Roth IRA contributions are not possible. Therefore, for some individuals, a nondeductible, traditional IRA is the only choice.

Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD.  Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars,  located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652.  Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

2019 IRA Contributions