Can I Contribute to Traditional IRA if I Make Over the Limit?

by W D Adkins

When your income reaches a certain level, the tax deduction for contributions to a traditional Individual Retirement Account is gradually phased out. The phase-out rules for IRAs can be confusing because there are two sets: one for Roth IRAs and another for traditional IRAs. If your income exceeds the limit for a Roth IRA, you cannot contribute funds to the account. That's not the case for traditional IRAs. Although you lose the tax deduction, you can continue to make nondeductible contributions no matter how much money you make.

Contributions

The maximum amount you can put in a traditional IRA each year is $5,000, or $6,000 once you turn 50. Your contributions are normally tax-deductible. However, if you or your spouse are covered by a retirement plan at work, the amount of the contribution you can deduct is phased out if your income exceeds certain limits. If you aren't covered by a retirement plan at work, there is no limit on the amount you can make and still get the tax deduction.

Phase-Out

Single people and heads of household have tax-deduction phase-outs of $56,000 to $66,000 of adjusted gross income (as of 2011) when covered by a retirement plan at work. This means your tax deduction starts to be phased out when your AGI reaches $56,000 and is completely eliminated when your income reaches the higher figure of $66,000. If you are covered by a retirement plan at work and are married filing a joint return, the limits are $90,000 to $110,000. If you are not covered but your spouse is and you file a joint return, the limits are $169,000 to $179,000. However, if either you or your spouse are covered and you file separate returns, the phase-out starts at zero and is complete when your income reaches $10,000.

Partial Phase-Out

Your tax deduction doesn't go away all at once. It is reduced gradually as your income increases. To figure out how much you can deduct, divide the difference between the lower and upper figures for your filing status into the amount your income exceeds the lower figure. Multiply the result by the maximum contribution to find the reduction in your allowed deduction. For example, if you are single and made $60,000, you earned $4,000 over the lower figure of $56,000. Divide by $10,000 ($66,000 minus $56,000), which is 0.4. Multiply 0.4 by the contribution limit of $5,000 for a reduction of $2,000, leaving a deduction of $3,000.

Distributions

Nondeductible contributions are viewed by the IRS as an investment and are not subject to the same rules as regular traditional IRA contributions. You may withdraw nondeductible contributions at any time. There is no tax liability since you didn't get a tax deduction to start with. You must file Form 8606 with your tax return to report nondeductible contributions and you must keep track of your cost basis. For a traditional IRA, cost basis simply means the sum of all nondeductible contributions, less any such contributed money you have withdrawn.

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