If you are working, you may be looking at your options to save for retirement. While there are typically multiple retirement savings plans available, whether through your employer or on your own, many individuals choose to invest in an IRA. In fact, any individual who is making earned income is eligible to make an after-tax contribution to an IRA. This deposit can then grow while being tax-deferred.
While this may sound great on paper, the team here at Maggi Tax wants to bring your attention to some traps that many fall into when contributing to an IRA that puts them on the receiving end of double taxation when it is time to withdraw money from that account. Today, we are going to take some time to explain the rules of the IRA game so that you don’t find yourself losing out on your hard-earned money.
Follow these general guidelines when contributing to a non-Roth IRA:
- You must have earned income as typically shown on a W-2 form.
- Contributions are capped at $6000 (plus an additional $1000 if you are 50+) annually.
- Understand what is known as the deductibility phase-out guidelines which change how much of your contributions are deductible based on your income, filing status, and participation in any other retirement plans during a year.
The good news is that many financial institutions that offer IRAs put safeguards in place that prevent you from contributing more to your account than is legally permissible. The downside is that your bank cannot monitor accounts with other banks, nor will they be able to track whether your investments were done on a pre-tax or non-deductible basis.
HOW TO REPORT PRE-TAX CONTRIBUTIONS
In order to prevent having to pay taxes a second time on money that you put into your IRA after taxes, you must be sure to report that taxes have been paid to the IRS. This is done via form 8606 and needs to be filed annually for monies you have invested into your IRA. Without this form being filed, the IRS can come after you to pay more taxes when you choose to withdraw money from your IRA. This, friends, is what is known as a double tax trap.
If you have not filed form 8606 in the past, don’t worry. You can file one with your next return and document historical contributions that fall into the non-deductible category. No matter what, it is vital to keep accurate records of contributions and filing status for the life of your IRA, as the burden of proof regarding investments will always fall on you, the taxpayer.
Your Maggi Tax team deals with the ins and outs of these kinds of tax laws daily, and we are always here to help our valued clients understand how these legalities can affect their retirement savings plans. For more information on this and other tax law topics, give us a call or stay tuned to our blog. We are always here to help you get the most out of your hard-earned money.