A traditional Individual Retirement Account (IRA) is a savings tool that allows savers to save and defer their income up to $5,500 in 2018 and $6,000 in 2019.
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If you are over 50, you can save and defer an additional $1,000 per year ($6,500 in 2018.)
Deferring your income simply means that the amount you invest into a traditional IRA is removed from your gross earnings. This could be limited by income phase-out limitations and cannot exceed the maximums noted above or 100% of your compensation.
For example, if you earned $40,000 in wages in 2018, opened a traditional IRA at your bank and funded $5,000, your Adjusted Gross Income (AGI) will be $35,000 barring any other income or deductions.
In the past, your income from your W-2 was inputted on line 7 of your 1040 and the IRA contributions were subtracted on line 32 to get to the AGI on line 37. The AGI was further reduced by your personal exemptions and deductions to get to your taxable income. For 2018, that has changed.
I have not seen the 2018 tax form yet, but it is expected to be simplified. The adjustments to gross income will not be on page 1 of the 1040, instead they will be on a separate schedule. I do not foresee it being difficult though.
Phase-out Limitations
First you need to determine if you can invest in a qualified savings plan at work. If you can, see the phase-out limitations below:
For 2018, the phase-out for single or HOH (or MFS and do not live with spouse) taxpayers starts at $63,000 and is completely phased-out at $73,000 of your Modified Adjusted Gross Income (MAGI.)
MAGI is calculated by adding the following back to your AGI:
- Student Loan Interest
- Domestic Product Activities
- Foreign Income excluded
- Foreign Housing deducted
- Savings Bond Interest
- Excluded Employer-Provided Adoption benefits
Married Filing Jointly or Qualifying Widow(er) phase-out starts at $101,000 and is completely phased-out at $120,000 of MAGI. If you file Married Filing Separately and live with your spouse, the deduction is phased-out at $10,000.
If your employer does not provide a qualified savings plan, the phase-outs are increased:
There is no phase-out if you file Single (or MFJ if neither you or the spouse is covered.) If MFJ and the spouse is covered, the phase-out is $189,000 to $199,000. If filing MFS, live with your spouse and the spouse is covered, the $10,000 phase-out rule still applies.
For example, say you and your spouse make a combined $190,000 and do not have a qualified retirement plan at work. If you earn $75,000, contribute the maximum of $5,500, and are under the age of 50, you get a deferral (deduction) of $2,475. This is calculated by taking the final phase-out of $199,000 and subtracting by your income. Multiply the 9,000 by 27.5% to get your maximum deduction.
Retirement Savers Tax Credit (Form 8880)
The Tax Cut and Jobs Act (TCJA) did not eliminate the retirement savers tax credit. If your AGI is under $63,000 for a MFJ couple($31,500 if Single), you are still eligible for this credit. The maximum credit is $2,000 and is calculated on a sliding scale of contributions. Last year, I contributed $5,000 and got a credit of 10% ($500) as a taxpayer filing MFJ, since we earned less than $63,000.
Contribution Deadline
For calendar year 2018, you can fund your traditional IRA by April 15, 2019. The accounts must always be funded by the tax deadline of the following year. That does not mean you cannot prepare your taxes in advance and claim the IRA deduction and credits, you just have to fund by the deadline. I have had many clients (and myself) to use their refunds to fund a HSA or IRA.
When to Take Distributions
If you want to take distributions, you must meet the hardship guidelines or wait until age 59.5 to avoid the 10% penalty. Typically distributions for higher education and a first-time home purchase are exempt from the 10% penalties for early distributions from an IRA.
Remember, when you take distributions from a Traditional IRA, the distributions become taxable income. The tax was deferred, meaning you did not pay taxes in the year you funded.
Once you turn 70.5, you must take required minimum distributions (RMDs.) The RMD is basically calculated taking your plan balance and dividing by your actuarial life expectancy. Each year your plan provider will calculate for you and send you the RMD for the next calendar year.
You can donate your RMD to charity as a Qualified Charitable Deduction (QCD.) To me, this is the best way to donate if you were going to give to a charity anyway. The RMD does not go on your income and you do not have to deduct as an itemized expense. With the standard deduction now $24,000 for those filing MFJ, it’s a great way to give!
Where to Start a Traditional IRA
I am going to give a few recommendations, but note I do not represent any of the companies I mention or get compensated. These examples are for informational purposes only.
- Your Bank. Most banks offer this service. Probably the lowest return and most conservative means to invest.
- Your Insurance Company. I use State Farm and they offer an IRA. I know because they always call me!
- Full Service Broker. These are companies like Edward Jones. They are usually paid on a commission or fees, so I do not believe they are truly independent. They want your money in order for them to make money. I do not recommend this option.
- Self Service Broker. This is my personal vehicle. I used Scottrade, but now they were acquired by TD Ameritrade. I do not like the functionality or offerings of TD Ameritrade as much. With this you can direct your own savings in individual stocks, bonds, CDs and my favorite-Vanguard Funds. TD Ameritrade does not offer Admiral shares of Vanguard, but you can still buy investor shares.
- Vanguard. Unless you are a professional, it’s best to invest in a total market fund and let it sit for 40 years. I love Vanguard due to the super low fees and broad allocations. I invest in their total stock market fund, bond fund and treasury fund. Remember KISS (keep it simple stupid) and go here.
I hope this article helps you. I wrote it after reviewing my Google search terms and saw that this title was my number one term, but the closest thing I had written was tax impacts of the TCJA on a Roth IRA.
If you need additional information or help with your taxes, please let me know. You can comment below or email me at contact@sidehustleretirement.com.
