taxes

Income limits for IRAs

George Saenzq_v2.gifDear Tax Talk,
If a working spouse has a 401(k) and has income that exceeds the limits for a deductible IRA, can the nonworking spouse and the working spouse both fund IRAs with nondeductible contributions?
-- Sarah

a_v2.gifDear Sarah,
The deduction for an IRA is limited when the individual (or if married, one or both of the spouses) is an active participant in a pension plan and his or her modified adjusted gross income, or AGI, exceeds a certain threshold.

For 2009, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA is reduced (phased out) if your modified AGI is:

Modified AGI limits for IRA contribution deduction
  • More than $89,000 but less than $109,000 for a married couple filing a joint return or a qualifying widow(er),
  • More than $55,000 but less than $65,000 for a single individual or head of household, or
  • Less than $10,000 for a married individual filing a separate return.

If you either live with your spouse or file a joint return, and your spouse is covered by a retirement plan at work but you are not, your deduction is phased out if your AGI is more than $166,000 but less than $176,000. If your AGI is $176,000 or more, you cannot take a deduction for contributions to a traditional IRA.

For 2010, the modified AGI limits are:

  • More than $89,000 but less than $109,000 for a married couple filing a joint return or a qualifying widow(er),
  • More than $56,000 but less than $66,000 for a single individual or head of household, or
  • Less than $10,000 for a married individual filing a separate return.

If you either live with your spouse or file a joint return, and your spouse is covered by a retirement plan at work but you are not, your deduction is phased out if your AGI is more than $167,000 but less than $177,000. If your AGI is $177,000 or more, you cannot take a deduction for contributions to a traditional IRA.

If you cannot claim a deduction for an IRA contribution, you can contribute to a nondeductible IRA. A nondeductible IRA is somewhat similar to a Roth IRA, except that withdrawals result in some ordinary income. Because Roth IRAs are completely tax-free, they are preferable to a nondeductible IRA. However, individuals with higher levels of income cannot contribute to a Roth IRA.

A disadvantage of IRA savings is that withdrawals result in ordinary income. Some people would rather invest the funds in regular savings. The advantages of regular savings are that the investment may qualify for the 15-percent long-term capital gains preferential tax rate and there is no penalty for withdrawing the funds prior to age 59½.

One possible advantage with a nondeductible IRA is the ability to convert it into a Roth IRA. Currently, higher-income taxpayers are precluded from converting IRAs into Roth IRAs. In 2010, the income limits are removed for IRA conversions. If you made nondeductible contributions before this year, you might be able to get that Roth IRA that you are otherwise unable to have because of income limits. See my prior article on 2010 Roth IRA conversions.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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