As you prepare your 2017 tax return, use the information you collect both to make the best IRA contribution choices for 2017 and plan IRA actions for 2018. Six ways to consider:
1. Maximize IRA Contributions for 2017
2017 IRA contributions can be made until April 17, 2018, the due date for 2017 tax returns. The maximum IRA contribution for both 2017 and 2018 is $5,500 ($6,500 for persons age 50 or older) or the amount of earned income, whichever is less. However, the amount of modified adjusted gross income (MAGI) reported on your tax return may limit:
- The maximum contribution to a Roth IRA
- The allowable tax deduction for a contribution to a traditional IRA, for persons covered by an employer’s retirement plan
These IRA limits for 2017 can be seen at https://www.irahelp.com/2017.
The information collected for your return can help you both make the largest possible contribution by April 17 and choose the best kind of IRA for you to contribute it to: Roth IRA or traditional IRA.
For instance, if you are in an unusually high tax bracket in 2017, a large tax deduction for a contribution to a traditional IRA may be uniquely valuable. But if you expect your future tax bracket rates to be comparable or higher than in 2017, a Roth contribution may be best for the future tax-free income it can provide.
2. Reverse 2017 IRA Contribution Mistakes
You aren’t necessarily stuck with the kind of IRA contribution you made earlier in 2017. A contribution to a Roth IRA can be “recharacterized” as one to a traditional IRA, and one made to a traditional IRA can be recharacterized to Roth IRA status. Information you discover preparing your tax return may motivate you to make a switch. Examples:
- If an expected deduction for a contribution to a traditional IRA isn’t allowed on the return, the contribution can be reversed to be one to a Roth IRA.
- When MAGI on a return turns out to be too high to permit a contribution to a Roth IRA, a Roth contribution can be recharacterized as a nondeductible contribution to a traditional IRA.
The deadline for recharacterizing 2017 IRA contributions is October 15, 2018.
3. Accelerate Contributions for 2018
Information collected for your 2017 return can help you project best IRA contribution choices for 2018, enabling you to make earlier contributions in 2018 to maximize IRA benefits.
For instance, contributing on the earliest date possible for a year, January 1, rather than on the last date possible, the due date for the year’s tax return, generates 15½ months of extra investment returns on the contribution for the year. That higher balance then compounds over all future years until funds are withdrawn from the IRA. Doing this every year multiplies the effect. Making contributions as early in the year as possible instead of at the last minute can significantly increase an IRA’s value by retirement.
4. Make and Plan Children’s Contributions
Be sure a Roth IRA contribution is made for every child who reports earned income on a return filed for 2017. There is no lower age limit on eligibility to contribute to a Roth IRA. Contributions can be funded with money received by gift, so a child does not need to use actual earnings to make a contribution.
(A contribution to a traditional IRA will produce taxable future income and little tax savings when deducted by a child in a low tax bracket.)
If a child owes “kiddie tax” for 2017 on unearned income in an investment account, minimize the tax going forward by making future gifts to the child to fund Roth IRA contributions, instead of to a conventional investment account in the child’s name. Roth IRAs are not subject to kiddie tax.
Accelerated, early-in-the-year IRA contributions are even more valuable for children because of the greater number of years of compound investment returns they may earn. Plan to make Roth IRA contributions for a child as fast as earnings up to $5,500 come in during 2018.
5. Consider Reversing a 2017 Roth IRA Conversion
If you converted a traditional IRA to a Roth IRA during 2017, the value of the pre-tax funds in the traditional IRA is includible in income on your 2017 tax return. But if the income tax cost proves too high, the conversion can be reversed through recharacterization. Examples:
- Investments in the IRA have declined in value sharply since the conversion. You can recharacterize the full IRA conversion back to traditional IRA status to avoid paying tax on value that no longer exists.
- You are pushed into a very high tax bracket by the conversion. You can make a partial recharacterization to reverse a calculated portion of the conversion to stay in a lower tax bracket.
The deadline for recharacterizing a Roth IRA conversion also is October 15, 2018.
6. Plan 2018 Roth Conversions Carefully
The new Tax Cuts and Jobs Act repeals the recharacterization option for Roth IRA conversions made in 2018 and later. (IRA contributions can still be recharacterized.) Roth IRA conversions now are final and can’t be reversed, so more care must be put into planning them to avoid making mistakes. Use the information collected for your 2017 tax return to project your tax and financial results for 2018 and carefully calculate the effects of any Roth IRA conversion you consider.
Ed Slott and Company