Edward A. Zurndorfer
Although it is past Dec. 31, 2019, federal employees and if they married, their spouses, have until April 15, 2020 (the deadline for filing 2019 income tax returns) to make their 2019 individual retirement arrangement (IRA) contributions. In the third of a series of columns discussing 2019 IRA contributions, this week’s FEDZONE column discusses Roth IRA contribution and distribution rules, and conversions of traditional IRAs to Roth IRAs.
Roth IRA Contribution Rules
Contribution to Roth IRAs are always nondeductible. That means there are no “up-front” tax benefits when an individual contributes to a Roth IRA. In addition, there are no forms that have to be filed with one’s income tax return in the year contributions are made to a Roth IRA. This includes no filing of Form 8606 (Nondeductible IRAs) which is filed in any year an individual contributes to a nondeductible traditional IRA.
For 2019, the combined limit for contributions to traditional and Roth IRAs is the lesser of $6,000 (plus $1,000 if age 50 or older as of Dec. 31, 2019) or earned income (wages/salary or self-employment net earnings).
Like traditional IRAs, there is a requirement for an individual (or the individual’s spouse) to have some type of earned income in order to contribute to a Roth IRA. Earned income includes wages or salary, commissions, self-employment income, or nontaxable combat pay. Compensation does not include income from investments, pensions or annuities, Social Security benefits, or rental income.
There has never been an age limitation for contributing to a Roth IRA. The only limitation (besides one must have earned income) for contributing to a Roth IRA is the amount of one’s modified adjusted gross income (MAGI), as presented in the following table:
2019 Roth IRA Contribution “Phase-Out” Based on Modified Adjusted Gross Income (MAGI)
|Filing Status||MAGI1 “Phase-Out”|
|Married Filing Joint or Qualified Widow/Widower||$193,000 – $203,000|
|Single or Head of Household||$122,000 – $137,000|
|Married Filing Separate||$0 – $10,000|
1 MAGI equals adjusted gross income less Roth IRA conversion income, less income from a rollover from a qualified retirement plan to a Roth IRA, plus deduction for traditional IRA contribution, plus foreign earned income exclusion, plus foreign housing exclusion or deduction, plus excluded US savings bond interest, plus student loan interest deduction, plus tuition and fees deduction.
The IRS has a worksheet in Publication 590-A (Individual Retirement Arrangements – Contributions) that allows individuals to compute the amount of their allowable Roth IRA for 2019 based on their 2019 MAGI. The worksheet is reproduced below:
Roth IRA – Reduced Contribution Worksheet (2019)
|1. Enter MAGI for Roth IRA purposes||$ _______|
|2. Enter: $193,000 MFJ or QW, |
$122,000 Single or HOH,
$0 if MFS
|3. Subtract line 2 from line 1||$ _______|
|4. Enter: $10,000 MFJ, QW, or MFS, |
$15,000 Single or HOH
|5. Divide line 3 by line 4 and round the decimal to three places. Do not enter more than 1.000||$ _______|
|6. Enter the lesser of $6,000 ($7,000 if age 50 or older) |
or taxable compensation
|7. Multiply line 5 by line 6||$ _______|
| 8. Subtract line 7 from line 6. Round up to nearest $10. |
If less than $200, enter $200
|9. Enter contributions for the year to other IRAs||$ _______|
|10. Subtract line 9 from line 6||$ _______|
| 11. Reduced Roth IRA contribution limit. |
Lesser of line 8 or 10
Some Traditional IRA Rules Apply to Roth IRAs
Several rules that apply to traditional IRAs also apply to Roth IRAs, including:
· Contributions may be made up to the original due date of an individual’s tax return with no extensions. This means that the deadline for making contributions to a Roth IRA for tax year 2019 is April 15, 2020, the due date for filing 2019 individual tax returns.
· There is a 6 percent penalty on excess contributions
Roth IRAs Distribution Rules
As mentioned previously, contributions to Roth IRAs are made with after-taxed dollars and therefore are always nondeductible. The contributions made to a Roth IRA can be withdrawn at any time income and penalty tax-free. The accrued earnings in a Roth IRA may be withdrawn income and penalty tax-free if the distribution is a qualified distribution. A Roth IRA distribution is qualified: (1) If the distribution is made after a five-year holding period. The five-year holding period begins on the first day of the first year for which Roth IRA contributions were made and; (2)One of the following applies: (a) The Roth IRA owner is age 59.5 or older; (b) The distribution is due to death or disability, or (c) The distribution is eligible for the first-time homebuyer exception to the 10 percent penalty tax on early distributions.
Conversion of Traditional IRAs to Roth IRAs
Since Jan. 1, 2010, the IRS has allowed individuals to convert their traditional IRA funds (and some other untaxed IRA funds) to Roth IRA funds by paying income tax on any account balance being converted that has not already been taxed (e.g., the traditional IRA balance minus any nondeductible contributions). Originally, there were income limits that prevented high earners from performing such conversions, but those restrictions have since been lifted.
Many individuals have reasoned that since there are no income limits to prevent high earners from making nondeductible contributions to traditional IRAs, and since anyone can convert traditional IRAs to Roth IRAs, high earners can simply contribute to a traditional IRA (with a nondeductible contribution) and convert the traditional IRA immediately to a Roth IRA. Thus, they can legally circumvent income limitation rules and taking advantage of the Roth IRA’s valuable benefits. The reason that no taxes would be owed on the conversion. This is because the converter would be converting the exact amount that he deposited – and on which he or she has already fully paid income taxes. Thus, the concept of the “backdoor” Roth IRA.
But the IRS does not allow converters to specify which dollars are being converted as is true with stock owners who can identify specific shares of stock being sold. For the purposes of determining taxes on conversions, the IRS considers a person’s non-Roth IRA money to be a single, co-mingled sum. Hence, if an individual has any funds in any non-Roth IRA accounts, it is not possible according to IRS rules to contribute to a traditional IRA and then convert that specific account to a Roth IRA as suggested by some individuals. Conversions must be performed on a pro-rata basis of all IRA money, not on specific dollars or accounts. The following example illustrates:
William has $45,000 in a rollover traditional IRA (untaxed money) and then attempts to utilize the strategy above to avoid income limitations on a Roth contribution by making a $5,000 nondeductible contribution to a traditional IRA and then convert that account to a Roth IRA. In that case, the IRS will calculate that William owes taxes on an additional $4,500 of income. This is because the IRS will look at the $50,000 in total non-Roth IRA money ($45,000 in a rollover traditional IRA never taxed, and $5,000 contributed to a nondeductible traditional IRA) as it were one account. Because 90% of that balance (i.e., $45,000 of the $50,000) is untaxed, William owes taxes on 90% of the conversion amount of $5,000 (i.e., $4,500). Furthermore, after paying taxes on the $4,500, William will need to track that he has $4,500 of already-taxed non-rollover money in his rollover traditional IRA account – which will not only complicate matters from an accounting perspective for years to come but may also prevent him from rolling the money into an employer’s 401(k) plan (including the TSP) in the future.
Situations in which pro-rata calculations must be done for conversions are not rare; a large percentage of today’s federal employees with rather large salaries started working before Roth IRAs were available and have non-Roth IRAs as result. Many left jobs and moved 401(k) money into rollover IRAs. Others may have accumulated SEP IRAs or SIMPLE IRAs along their career paths as well.
Directly transferring all of an employee’s pre-taxed rollover traditional IRA or contributory traditional IRA money into their traditional TSP account (using Form TSP-60) prior to making a traditional IRA to Roth IRA conversion may be helpful for some employees.
Those employees who performed Roth IRA conversions during 2019 must report their conversions on IRS Form 8606 (Nondeductible IRAs) when they file their 2019 income taxes in spring 2020. Those individuals who performed conversions of traditional IRAs to Roth IRAs during 2019 must pay the full amount of federal and state income taxes due when they file their 2019income tax returns.
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