As we once again enter the season of tax filing, some people may be thinking of making an IRA contribution to reduce their 2015 tax liability. Great idea! But beware of the 2015 IRA contribution limits ($5,500, or $6,500 if age 50 or older) as well as the 2015 IRA deduction limits. Let’s say you are the husband in a married couple and you wish to make a $5,500 IRA contribution but you also have a 401(k) plan at work for which you are eligible to participate. If your modified Adjusted Gross Income (MAGI) is $118,000 or more, you get no deduction. If it’s $98,000 or less, you get a full deduction. If your income falls in between you get a partial deduction.
Here’s where it gets tricky. If you “commingle” your funds—that is, create one IRA that contains both deductible contributions and non-deductible contribution, your life will get more complex as you attempt to track your cost basis during the withdrawal phase of the account. The cost basis in a non-deductible IRA is not taxed upon withdrawal, so it’s important to keep appropriate records proving your basis. Our suggestion is to create a separate IRA for non-deductible contributions so that it’s clearly separate and apart from a Rollover IRA for example. Then you can mentally compartmentalize the different buckets of money as you begin to accumulate various retirement accounts and their inherent tax consequences.
Keep in mind that meticulous recordkeeping will also assist heirs. If a premature death occurs for an IRA holder, many heirs will look at an IRA and assume that there is no tax basis, perhaps making it fully taxable upon withdrawal. Strong records will alert an advisor that there is tax basis and reduce the tax burden for heir withdrawals.
-Walt Mozdzer CFP®, CAP®