EPS 16 - IRA Basics Explained: Contributions, Deductions & Rules

 In this episode of the Pink Money Podcast, Jerry covers everything you need to know about IRA contributions ahead of the April 18th tax filing deadline. He explains the difference between traditional and Roth IRAs, contribution limits, deductibility rules, and how phase-outs work based on income. Jerry also shares tips on recordkeeping, rollovers, and why keeping track of forms like 8606 and 5498 is essential to avoid being taxed twice. 

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Transcript

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This is Jerry, and welcome to the Pink Money Podcast. I'm your host, Jerry Williams, and we talk about all things related to money from a gay perspective. And you know what I noticed this year? is that April is already here, and the tax filing deadline is just in a couple of weeks, which is for 2023. Tax filing deadline falls on the 18th, which is a Tuesday. So normally, tax filing deadline is, of course, the 15th, but the 15th this year is on a Saturday, and then we have the 16th Sunday. 17th is Monday. 18 And I know that, you know, when the tax filing deadline falls on the weekend and normally pushes the tax filing deadline out to the next business day, in this case, the 17th, I believe is Emancipation Day in Washington, D.C. So they then push this out to Tuesday, the 18th. So that's pretty good news for anybody who is a procrastinator on their taxes and gives you a little bit of extra time. I don't know, but you want to, if you're capable, you want to be maxing out your IRA contribution for the year. And the reason why, of course, is the more money you save for retirement, then the better off you're going to be in the long run. And it doesn't really matter if you're saving in your IRA or your 401k or 403b, you know, whatever. It's just really important that you save for retirement, period. So in the grand scheme of things, what you want to do, of course, when you're looking at your budget is you want to save for yourself first, right? You want to have three to six months worth of living expenses. I always suggest, you know, if you're capable of pushing that out further, because you always know that you're always going to need more money than you think. And Any kind of situation can upset the apple cart, and we might need more money than we think. And so try to go for a year if that's possible. Then you want to pay down any debt next, and then you want to save for retirement third. And then anything else you want to do after that, like save for or put some money aside for college funding or your vacation or what have you. So just a little priority of money. And in this case, whether you are contributing to your Roth IRA or your traditional IRA, the limits for 2023 have increased. And they usually increased every couple of years or so. And in this year, the 2023 contribution limit is$6,500 for everyone unless you're 50 plus, and then it goes up by$1,000 to$7,500. In last year, 2019 and 2022, it was$6,000 for individuals,$7,000 if you're 50 plus. And in 2015 to 2018, it was$5,500 for individuals,$6,500 for 50 plus. So you can see it does change, you know, every now and then. And, you know, One thing about the IRA is to keep in mind that it stands for individual retirement account, not joint retirement account. Now, many people who are married consider... you know, your husband or your wife's IRA, their IRA as well. And I guess you can, you know, in the sense that if you're both contributing to it, you're under one household, you're each other's beneficiaries, you know, the money that goes into it is from your joint account, et cetera, et cetera. So, yes, in that sense. But again, it's not. They're two separate accounts. In fact, some institutions, if you call, let's say, your... bank or maybe your investment company they won't let you talk about your spouse's account unless you're you know you have authorization or you know you're like your wife or your husband is there to provide authorization so it just really depends on the institution but nevertheless like i said this would be an individual or a roth ira a traditional or roth ira that's what i meant sorry so the main difference between the two in case you didn't know is traditional ira means essentially the money that goes into that is pre-tax money and when it comes out later on down the line when you're at least 59 and a half that's when you can pull the money out without incurring an irs penalty for an early withdrawal then the money comes out and you start paying taxes on whatever you took out. You withdraw$10,000, you claim$10,000 on your income taxes, your tax return and pay income taxes on that. Versus the Roth IRA, that money is essentially after-tax money. You've already paid taxes on it. So when it comes out later on down the road, as long as it's in there at least five years, you're 59 and a half or older, then everything that comes out is tax-free because you already paid taxes on it. And you only pay taxes once on your money. You never pay taxes on it twice. At least that's what's supposed to happen. So commonly, I find that many people will put money into a traditional IRA and they forget to file their Form 8606. And what's important about that is, especially if you're doing your taxes on your own. So Form 8606 records to the IRS money that you're not able to take a tax deduction on because maybe you're in the phase-out level. So What happens with your traditional IRA, right, is the money you contribute, let's say you're contributing the full$6,500. That money comes directly out of your checking account, and it goes into your IRA, Roth, traditional, either or. But nevertheless, that's the contribution. Now, deductibility is what turns that into pre-tax or after-tax money. Because, again, what's in your checking account came out of your paycheck, typically, and your employer has already withheld taxes. So that money in your checking account is already after-tax money. You put that into your IRA. It's after-tax money, Roth traditional, either or, after-tax money goes in. And then on your traditional IRA, if you're able to take a full tax deduction, then you tell the IRS that you contributed$6,500 to your IRA and you take the full$6,500 deduction. Again, Roth IRA, you contribute$6,500. It's after-tax money. Tax has already been paid. You don't get a tax deduction. You will record to the IRS that you made an IRA contribution. but you will, again, know that it's in your Roth IRA and denote that it's in a Roth IRA, so no tax deduction. So on top of that, you have to look at whether or not you can take a tax deduction on your IRA contribution. And again, I'm talking about traditional, okay? So when you contribute money to your retirement account, Oftentimes, people will sometimes conflate what they contribute through their work, like their 401k or their 403b, and think that is how your IRA works. And they have some similarities, but they're different. And mainly, let's just say that the 401k is a defined contribution plan. So it's not a defined benefit plan. A defined benefit plan would be like a... a pension when you retire. So you don't contribute to that, just your employer does. They set money aside for you that eventually when you put your time in and you reach a certain age, then they will start paying you a pension, right? And then you will pay taxes on that pension money because it's money that's never been taxed before. Your employer contributed the money to that and they took the tax deduction. So therefore, it's pre-tax money. When it reaches you, it goes into your check-in account, that's when the taxes come due. So it's a little bit different with your IRA. So your IRA, you may or may not be able to take a tax deduction on your contribution. And that really just depends on how much money you make because the IRS has limits on your contribution so much as they do with deductibility. Now, with that being said, there are limits to how much you can put into your IRA based on how much you earn. So what I mean by that is let's say you only made$5,000 for the year. Now, even though the IRA contribution limit is$6,500, if you only earned$6,500,$5,000 for the year, the most you could put in would be$5,000. Similarly, if let's say you had your child and you wanted to open up an IRA for your child, that can be done, right? If you're setting up an investment IRA, meaning putting in stocks, bonds, mutual funds, whatever, then the child, of course, cannot... manage that IRA themselves because kids cannot invest, right? It's prohibited. So you as the custodian, adult, parent, guardian, what have you, you're the one that sets up the IRA. You make the contributions to the IRA and you invest it accordingly. Again, you know, speak with your financial advisor, your investment company if you need help. You know, always seek competent investment, tax, and legal advice wherever it's, you know, needed. So in this case, going back to the IRA, so the most you can put in is how much you've earned. Same with children. So if your child made, let's say they did a, I don't know, a commercial, and they made, I don't know,$2,500, right? then if that's the most they made for the year, and I'm talking about from January to December, that's the calendar year, then that's how much money they can put in. No more, of course you can always do less, but no more than that. So if grandparents, you know, wanted to contribute to the child's IRA or even your IRA, hey, I'm going to give you a gift of, you know,$6,500 and I'll make the IRA contribution for you. Well, they can, right? In the sense that they can give you the check, you can drop it into your bank account, and then you're$6,500 richer. So as long as you've made$6,500 for the year, then that money can go into your IRA. If you never worked for the year, then you cannot put any money into your IRA unless matter who gives you the money because you have not had earned income the only thing that could go into an ira is earned income money essentially that you worked for so even though your parents grandparents whatever you know are generous and they give you that money you may or may not be able to contribute it to your ira because you either have or have not worked and made earned income. So a gift can be nice, but if they give you the money and you can't make the contribution in full, let's say, because, again, you didn't work, you didn't make that much money, then that money would just go into, if you wanted to invest it, just a regular investment account, either your name, joint name, what have you. So it doesn't matter whether that's, again... whatever type of IRA. So in a 401k, like I said, that money would go through your employer because you set up how much you want to withhold from your paycheck into your defined contribution plan your 401k so you can set usually a percentage or a certain dollar amount and that would go in there and your player will generally match as well you know sometimes they do one percent two percent three percent you know it really just depends and that that depends on you know how generous they are and you yourself you know you can contribute uh your money into either, I'll just call it a pre-tax or after-tax account with your 401k. So similarly, it's like a traditional or Roth, you pre-tax or after-tax. And again, that money, if it's going in pre-tax, you've never paid taxes on it. You will though, when the money comes out later on down the road. And if you're in the Roth 401k, then you pay taxes immediately on it. And then it goes in as after-tax money. And similarly, when it comes out later on down the line, it will come out completely tax-free. So a lot of people like that option, especially if you don't know what taxes are going to be later on down the road. You don't want to guesstimate, think what they possibly will be. You don't want the headache of trying to figure out, you know, gee, will I have the money to pay taxes or not? I don't know. Just go ahead and do the Roth IRA. Then you're better off and you don't have to worry about that because you'll get not only what you put in, back tax-free, but also the earnings, what has grown. So let's say you contributed over the years and you've put in, I don't know, let's just say, you know,$250,000 over the course of, you know, 30-some years, what have you, and it's grown, you know, I don't know, twice that amount, then everything would come out completely tax-free. So On the 401k or 403b, the most you can put in for 2023 would be$22,500. The most you were able to put in last year, and again, we're talking on a calendar year basis, would be$20,500. And it was less in 2020 and 2021. In fact, it was in 1905. So again, those levels change as well. So you just have to budget inside, again, what you can put. feel you're able to put in. Now, one thing about the 403b or the 401k is when you put that money in, if something challenges you and goes awry, and maybe you need to try to yank that money out, you're not really going to be able to. Sometimes they have an emergency withdrawal provision where you can get some money out. Sometimes you can take a loan. But those are really the only ways. Now, in your IRA if you put the money in you decide for whatever reason I've over contributed let's say I put in too much money I put in a thousand dollars more than I'm supposed to you can always take that out you just you know pull it out and then if you typically don't pull it out, you'll have a 6% excess penalty for leaving that money in. So you don't want to leave it in there. You don't want to pay a penalty. So you will take it back out. But nevertheless, if you've got the money in your IRA and for whatever reason you need to pull it out, if you're under 59 and a half and it's not for a qualified reason like to buy a house or to pay education expenses or something like that, then if it's not for one of the qualified reasons for a withdrawal, you'll pay a 10% penalty for an early withdrawal because you're under 59 and a half. Of course, if you're over that, you don't even have to worry about that. And then you just, you know, would pay a 10% penalty on what you took out. Okay. And you just record that on your tax return to the IRS. Just to let you know that the IRS is going to be notified via 1099 from your provider so they will know that, hey, you know what, we've got a withdrawal here and it better match up with what you got on your tax return, right? So the two will match up. The IRS is going to look for that and make sure that you've recorded the amount of money that you took out of your IRA, if you did. And you will also receive from your investment company$5,498. And that form tells the IRS, hey, an IRA contribution was made. So again, they're going to look to see, did you record that contribution on your tax return? And did you claim$6,500 or you only put in according to the$5,498,$3,000? So again, they have to match up. Now, the IRA contribution, however, can be made up through tax filing deadline of the following year. So in this case, you had 12 months to put in your total IRA contribution for the year. However, you have up through tax filing deadline to still make your IRA contribution. So January, February, March, April, all the way up until April the 18th. So oftentimes with your IRA contribution, as long as usually it's postmarked by the 18th, then generally your investment company will accept that. Totally verify that with them because you just really want to make sure that that is going to be the case. But in my experience, that has always generally been the case as long as it's postmarked by the tax filing deadline. So Going back to, again, deductibility, so I don't forget that. So what you really want to look at, again, is whether or not you are covered by an employer-sponsored plan in terms of when you try to take a tax deduction on your IRA contribution. And this case, again, I'm talking just strictly traditional IRAs. So... They are what are called phase-out limits because the IRS says, you know, if you're contributing to your 401k and you're already putting pre-tax money in there, and then you're trying to contribute to your IRA and take a tax deduction to turn that into pre-tax money as well, then they're not going to let you double dip in that way. So... If you're covered by your 401k at work and you're making contributions to that, which is what you should be doing, you're not going to be able to take a tax deduction on your traditional IRA. So you probably just want to go ahead and pop that in your Roth. However... If you don't have a Roth and you don't want to open a Roth for whatever reasons, because let's say you've been contributing to a traditional IRA for a long, long time, or it doesn't make sense for you to open a Roth IRA in, let's say, something that has a very high investment minimum and your Roth IRA will not meet that minimum, but you have enough money in your traditional IRA, just keep dropping it in there. So money works best when it works together. So you really don't want to separate small amounts of money versus large amounts of money. You want to keep that money together because again it works best when it works together so if you do have to make that to your traditional IRA fine it's not a problem if you're able to take the tax deduction then again you will record that to the IRS on your return and then take the tax deduction if not then you record that total contribution that you were unable to deduct on form 8606 Okay, so if you made$6,500 contribution, you're covered by 401k at work, you cannot deduct any of it, then you will record$6,500 on your form 8606, thereby telling the IRS, I'm not taking a tax deduction, but hey, I did make the contribution. Now, you want to definitely keep track of all these 8606s over the years. So Eventually, when it comes down the line, you will know what your basis is so that you don't pay taxes unnecessarily on the contributions that you've made that you already pay taxes on. You only want to pay taxes on anything that's never been taxed before. And the only way the IRS is really going to know that when taxes come due because you're starting to take withdrawals and maybe you've even forgotten taxes You know how much you've contributed. You need to take all those 8606s and add them all up and then figure out again what your basis is. So when you start taking withdrawals, then you know that this much is taxable, this much is not taxable. Okay? So on top of that, like I said, if you... are single or married or head of household or married filing separately, then there are phase-out guidelines. And so, for example, if you're single or head of household and your modified AGI is$68,000 or less, then you can take a full deduction up to the amount of your contribution. And again, I'm talking about not being covered by an employer-sponsored plan either. And if you earn more than$78,000. So let's say you are at$68,000 but less than$78,000, you can take a partial deduction. And if you earn$78,000 or more, zero deduction. So if you don't have a 401k at work and you contributed$6,500 to your IRA, you're fortunate enough to make more than$78,000 for the year, good for you. But if Good for you for making the IRA contribution, but you're not going to be able to take a tax deduction on it. So thereby, fill out your tax return and record that$6,500 IRA contribution or whatever it is on Form 8606. And if you're married filing jointly, then it's$109,000 or less full deduction. If you're married filing jointly with more than$109,000 but less than$129,000, you can take a partial. If you're earning$129,000 or more, no deduction. Married filing separately, if you earn less than$10,000, partial deduction. Married filing separately,$10,000 or more, no deduction. So you want to be aware of that because, again, there's these rules that you bump up against. So you just don't want to... You don't want to get in trouble with the IRS because, again, you're trying to take a tax deduction that you don't really– you're not going to be allowed to because they will definitely take a look at that and probably reject your tax return if you did that. So those are just a few things to keep in mind. You can take a look at all these– phase out limits etc and then you can run the calculations yourself many times lots of you know websites and investment companies you know will help you calculate what your contribution limit is and whether or not it's deductible and you know of course your investment company or your financial professional should be able to help you out as well so you want to definitely put money into your IRA don't put more money than you can but put in as much money as you can. And similarly with your 401k or 403b, you want to put in as much money as you can. They're not going to let you put more money than you can, than you're allowed to, I should say. But you want to put in as much money as you can. And definitely if you're unfamiliar with how to invest that money, again, you need to get some professional guidance because I've often seen Especially with teachers, you know, that a lot of times you have limited investment choices. And I should also say with 401ks as well, because your company will generally be solicited by, you know, an investment company or some salesman who has alliances with certain companies. 401k providers and you might have a huge range of choices but maybe your employer only selected a couple so that just limits the range of investments that you have maybe you're limited to like in a 403b just an annuity and maybe it's just a fixed annuity that only pays let's say interest and or maybe you could do a 403b7 where you have access to mutual funds That really just depends. And similarly with your 401k, you might only have some very plain Jane vanilla type of investments, like let's say a growth fund, which is just large cap stocks. Or you might have a large cap, mid cap, and small cap, and maybe a worldwide fund or something like that. So you can divvy it up as you see fit. And you can adjust your percentages for future contributions, as well as you can reallocate your portfolio whenever you see fit. And that just, again, there's just so many variations to that. As you can see, it can either be very complicated or very simple. It's really up to you. And that goes back to how much risk you want to take, a little or a lot. And if you're unsure, again, work with somebody so they can help you out. And oftentimes, going back to what I was just thinking about with teachers, that usually they'll have somebody like an investment professional come into the school and they'll be available to help, you know, give you advice and guidance and help educate you. And that can be helpful. But, you know, you just really sometimes want to get some outside advice because usually in your 401k or 403b, they're looking at just that small piece of your Now, that may be all the investments that you have, but it may only be a small portion. So it could be that you have your IRA for you and your spouse. It could be that you have your investment account on top of that. And maybe you have some additional investments. Either you're doing real estate, you have some... investment properties, or maybe you invest in, you know, gold on the side, you know, there's all kinds of different things that you could be doing that they don't take into account. So you don't want to be overweighted in any one particular sector, you want to just be, you know, it's always a good idea to be diversified, right? Like, again, I've said before, you know, you don't want to keep all your eggs in one basket, because you definitely can go downhill quickly, like we've seen many, many, many times. So keep a diversified portfolio. But that's, again, strictly up to you. It depends on how much risk you want to take. And you want to work with somebody who really can take into account your full potential financial picture and give you the best advice and guidance as possible. So again, working with somebody, in my opinion, is just one of the best ways. When you put in place a financial plan, and I feel like a broken record in that sense, but because you want to work with your financial professional at least once a year to just review your overall situation and see that you're allocated properly, doesn't mean that that's the only time that you can work with him or her. You can hopefully visit them more often than that if you need to. Now, monthly, I would say that's way too much. And they probably won't even meet with you that often because what are you going to be talking about? I don't even know. Hopefully, you've already put this into a written plan so you don't need to visit them monthly. Probably not even quarterly. And many, many times, most financial professionals will see you just once a year. unless something changes in your overall situation. You lost your job, changed jobs. You know, you went to go to work for a nonprofit and you have a different type of investment plan or you had a pension plan and now you don't and you want to roll it over. Those are the situations that, again, you want to work with somebody. Speaking of rollovers, so if you do have money that's orphaned, let's say in a 401k somewhere, I used to work for blah, blah, blah, and I had a plan there, and then I switched this job, and then I had a little 401k there, and blah, blah, blah, so I got three or four hanging out there. Like I said, money works best when it works together, so you want to bring all that money together and put it into one account. Now, do you have to? No, but it's a good idea. Could you put them into individual IRAs? Yes. So that being said, too, if let's say you had your$6,500 a year as your IRA contribution, and let's say there's three different investment choices that you want to take advantage of, you could split that into$2,166 into all three of them, as long as you usually meet the investment minimum of whatever you're trying to put your money in. That can be done. Would you want to? I don't know. Depends. Maybe. Because don't forget, you have fees generally on top of all these investment products that you are purchasing. So you want to be cognizant of the fact that inside of these investment choices, there are fees. On top of that, you might have advisory fees that you're paying to that salesperson if you use that person who collects fees via that way. Or you might have just a... a fee by the investment company just for a custodial fee and it could be i don't know you know a hundred dollars a couple hundred dollars you really you know you need to ask and you need to be informed before you put your money in there so these these are the reasons that if you do invest on your own you know you really want to read through the contract that whatever you're signing so you know This is what I'm paying. This is how much I'm paying. And then you don't want to be surprised later on down the road and go, oh, well, I didn't know I was paying that. Well, you are. And if you didn't know, you should have known. And if your investment advisor who you worked with never told you, well, shame on them. And they can really get in a lot of trouble with that because they're supposed to provide you a form of ADV. And that shows you how much you're actually charging. And, of course, you want to know because... Not that it's a bad thing because everybody's got to eat, but you want to know how much you're paying. So that may be a lot to digest in one sitting. I don't know, but I think it's just important for you to take these things into consideration. You know, just to kind of recap where we're at, again, IRA contributions need to be made by April 18th of this year. And whether you make a full partial, doesn't matter. You may or may not be able to take a tax deduction on it if you put it into a traditional, depending on your tax filing status and how much money you earned and whether or not you're covered by an employer-sponsored plan. Read IRS Publication 590 if you want more additional information. Seek competent tax or legal or investment advice as it is needed. And then keep track of your Forms 8606 and your Form 5498. And all that will... be in your tax folder so that, again, over the years you can keep track of all this because you never want to be taxed twice on your money. You just want to pay the appropriate taxes when those taxes are due. So that's my spiel. Hopefully it makes sense. I'm sure that you guys are going to make the best decisions for yourself. And if you have any questions, you know, reach out. I'm always here to help you out and answer your questions to the best of my ability. Have a great day and we will talk soon.

UNKNOWN 33:21

Thank you.