There are only a few more days left of tax season, and even if you plan on filing an extension, you may still need to hit the April 15 deadline when it comes to your IRA contributions.
The IRS rules surrounding IRAs can be tedious, so now is a good time to review the regulations and how to stay compliant so as to avoid any unnecessary penalties.
1. You must be under age 70 ½ at the end of the tax year in order to contribute to a traditional IRA. Once you reach age 70 ½, you must begin to take the required minimum distribution (RMD). You can always take more than the RMD without penalty, but you will be subject to an additional excise tax if you take less than the RMD or no distribution at all.
2. To contribute to an IRA you must have taxable compensation listed on your income tax return. This includes income from wages, salaries, tips, commissions and bonuses. It also includes net income from self-employment. If you file a joint return, generally only one spouse needs to have taxable compensation.
3. You can contribute to your traditional IRA at any time during the year. In fact, dollar cost averaging is the recommended method for making the contributions. If you make monthly rather than an annual contribution, you will be playing the highs and lows of the market rather than being stuck with the market value on one date. You must make all contributions by the due date for filing your tax return—this due date does not include extensions. For most people this means you must contribute for 2012 by April 15, 2013. If you contribute between Jan. 1 and April 15, you should contact your IRA plan administrator to make sure they apply it to the right year.
4. For 2012, the most you can contribute to your IRA is the smaller of either your taxable compensation for the year or $5,000. If your wages were only $4,000 and you had no other compensation income, your maximum contribution will be only $4,000. If you were age 50 or older at the end of 2012 you can contribute a maximum of $6,000.
5. Generally, you will not pay income tax on the funds in your traditional IRA until you begin taking distributions from it. To minimize your tax blow, project the tax bracket you will likely be in at retirement age. If your income will be lower in retirement and you expect to be in a lower tax bracket then sheltering funds in a traditional IRA might be the best choice. However, if you expect tax rates to rise and your income to be substantial during your retirement years, you may elect to contribute to a Roth IRA and enjoy nontaxable distributions during the twilight years. ROTH IRA contributions are not deductible.
6. There are IRA Worksheets available to determine the amount of your deductible contributions. This IRS source also has a worksheet for determining the amount of your required minimum distribution. Or see the instructions for Form 1040 or 1040A for sample worksheets.
7. You may also qualify for the Savers Credit, formally known as the Retirement Savings Contributions Credit. The credit can reduce your taxes up to $1,000 (up to $2,000 if filing jointly). Use Form 8880 Credit for Qualified Retirement Savings Contributions, to claim the Saver’s Credit. You cannot take the credit if you made more than $28,750 (single), $43,125 if head of household or $57,500 if married filing jointly. You also do not qualify if you were under age 18 at the end of 2012 or if you were a student or if you were claimed as a dependent on someone else’s 2012 tax return.
See Publication 590, Individual Retirement Arrangements, for more about IRA contributions.
Bonnie Lee is an enrolled agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, Calif., and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Her new e-book Taxpertise for the Creative Mind Murder, Mayem, Romance, Comedy and Tax Tips for Artists of all Kinds is available at all major booksellers. Follow Bonnie Lee on Twitter and on Facebook.