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Are you covered by an employer’s retirement plan?

Good financial and tax planning is the product of good advice. Get bad advice and well, your financial plan is not as successful as it could or rather, should be.

When accumulating assets for retirement there are several ways or baskets to consider. The common baskets that hold our retirement nest eggs include the 401k, 403b, 457, profit sharing, Simple IRA, SEP-IRA, pension plan and a few others. However, the traditional IRA is often overlooked because most believe they are not eligible to contribute to an IRA. Ahhh, that's the product of bad advice.

The fact is, everyone is eligible to contribute to a traditional IRA, no matter how much money you make (yes, Bill Gates included) what you may or may not be eligible for is the deduction on your personal tax return. There are income limitations and coverage limitations but the fact remains, you can always make a non-deductible tax-deferred contribution to a traditional IRA. Remember, the Roth IRA is a different animal, but the traditional IRA should be considered when accumulating assets for retirement.

It's important to determine whether you are covered by a retirement plan at work, which affects your ability to deduct traditional IRA contributions.

Your ability to deduct traditional IRA contributions from your gross income depends on whether you're “covered by an employer retirement plan.” How do you know if your “covered?"

You’re covered by an employer retirement plan for a tax year if your employer (or your spouse’s employer) has a:

  • Defined contribution plan (profit-sharing, 401(k), stock bonus and money purchase pension plan) and any contributions or forfeitures were allocated to your account for the plan year ending with or within the tax year;
  • IRA-based plan (SEP, SARSEP or SIMPLE IRA plan) and you had an amount contributed to your IRA for the plan year that ends with or within the tax year; or
  • Defined benefit plan (pension plan that pays a retirement benefit spelled out in the plan) and you are eligible to participate for the plan year ending with or within the tax year.

Box 13 on the Form W-2 you receive from your employer should contain a check in the “Retirement plan” box if you are covered. Read that says "should contain a check" but in all the tax returns I prepared for 2010 there were a few where the box was not checked. Suspecting otherwise, I asked the client and of course the employee was covered by a pension plan and therefore the box should have been checked. This small oversight by the payroll company was the cause of a big mistake by a client that first filled out their return with online software and took deductions for two $5,000 traditional IRA contributions that they were no otherwise entitled to take.

You see in tax preparation software, if you don't check the box, it doesn't know that you are covered. The client was innocently following the W-2 and when prompted by the software to increase the refund by making IRA contributions, the client jumped at the opportunity, erroneously as we now know. So it's best to be safe, if you are still not certain, check with your (or your spouse’s) employer or discuss with your CPA or financial advisor.

These limits on the amount you can deduct don’t affect the amount you can contribute. However, you can never deduct more than you actually contribute.

Additional Resources:

Publication 590, Individual Retirement Arrangements (IRAs)

Tom Taylor, CPA is a fee-only, independent Financial Planner and Certified Public Accountant and can be contacted at Chesapeake Financial Advisors or Taylor & Company in Towson, MD. Tom believes that the greatest benefit of planning includes incorporating tax strategies with financial planning. Tom’s clients receive both services in one advisor. He is a member of NAPFA and the MACPA and AICPA.

Fee only independent financial planning advisor planner investments CPA Towson Baltimore Maryland Virginia

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