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Lev
Lev, Tax Advisor
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Experience:  Taxes, Immigration, Labor Relations
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Subject: Participation in deferred compensation pan under IRC

Customer Question

Subject: Participation in deferred compensation pan under IRC 403 (b) and contribution to a tradional IRA



My friend is working in an educational organization. Her employer set up a deferred compensation plan und IRC 403 (b) and deducts from her taxable wages and matched her contribution with his. On box 12 of W-2 he reported $9.00 without her permission. The contribution was reported on W-2 Box 12 Code E.
Regardless whether or not she was required to permit such contribution she is concerned for a different reason.
She never wanted to participate in the 403(b) plan, but rather she wanted to make a deductible contribution in the amount of $4,000 to her traditional IRA. She is worried that she will not be able to make such contribution as a deductible IRA only because her employer reported the combined contribution to his 403(b) plan. Is she right?
If she is right Is her contribution to an IRA be a non deductible resulting in no tax benefit, or would it be considered an excess contribution and subject to interest of 6% per annum ? (She is over 591/2 years old so no penalty is involved?
What are the risks in making such contributions before April 15, 2013?
Does the IRS have a matching between 403(b) and IRA? I viewed the worksheet for IRA contribution and no reference was made to Section 403(b)
Please advise
Submitted: 1 year ago.
Category: Tax
Expert:  Lev replied 1 year ago.

LEV :

Hi and welcome to Just Answer!

LEV :

Several issues...
1.
First of all she may contribute to IRA regardless of having retirement plan at work.
2.
Her deduction for the traditional IRA contribution is limited based on if she is covered by a retirement plan at work. See here - http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/2012--IRA-Contribution-and-Deduction-Limits---Effect-of-Modified-AGI-on-Deductible-Contributions-If-You-ARE-Covered-by-a-Retirement-Plan-at-Work
That limitation is applied regardless if she actually participated or not - but because she was ELIGIBLE to participate. If yes - the box on line 13 form W2 should be checked.
3.
If she may not deduct traditional IRA contribution - most likely she will be able to make nondeductible contribution into Roth IRA - and potentially her earnings will not be taxable as long as she will have Roth IRA at least five years.
4.
Is her contribution to an IRA be a non deductible resulting in no tax benefit, or would it be considered an excess contribution and subject to interest of 6% per annum ?
That is not the situation when she may not make a contribution - she definitely are allowed to contribute - so there is no excess contribution penalty. But she might be not allowed to deduct her contribution.
What are the risks in making such contributions before April 15, 2013?
There is no risk in making contributions but the risk is if you would claim a deduction in case she is not eligible.
Does the IRS have a matching between 403(b) and IRA?
Yes - administrators of both plans are sending information to the IRS and the IRS do have a matching verification.

JACUSTOMER-gswtlc5j- :

She is single and her modified AGI is more than $ 68,000. Therefore based on your link the IRA would be non deductible. She is no longer employed by the school, she resigned. Let say that that she will make a non deductible IRA, which creates a basis and next year she will take money out of IRA, in the amount of $ 4,000, can she tell her broker that the the taxable amount is zero on the ground that the gross distribution is equal to basis?

LEV :

If she makes a nondeductible contribution to the traditional IRS - she would need to file form 8606 with her tax return to report that fact - and yes - she will need the basis in her IRA.
That is not reported to the broker - she would need to keep track of her basis.
I think the better option is to make the contribution to Roth IRA.
However - if she plan to take the money out next year - I see no reason in making a contribution in the first place.

JACUSTOMER-gswtlc5j- :

Two comments regarding contribution to a Roth IRA:

She is 65 years old but her MAGI are more than more than $ 125,000. Therefore she is ineligible for a Roth IRA

All distributions received by her in 2011 were not taxable.

Please reply

LEV :

Based on your information - she is not eligible to make Roth IRA contributions - see here - http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Amount-of-Roth-IRA-Contributions-That-You-Can-Make-for-2012
So - her only option is to make nondeductible contribution to the traditional IRA.
However - after making IRA contribution - she may convert funds from traditional to Roth IRA - there is no AGI limit for conversion.

Expert:  Lev replied 1 year ago.
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Expert:  Lev replied 1 year ago.
Just in case you were not able to use the chat - I am switching to Q&A mode and porting the answer below.
Please feel free to communicate if you need any clarification or have other tax related issues.

Based on your information - she is not eligible to make Roth IRA contributions - see here - http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Amount-of-Roth-IRA-Contributions-That-You-Can-Make-for-2012
So - her only option is to make nondeductible contribution to the traditional IRA.
However - after making IRA contribution - she may convert funds from traditional to Roth IRA - there is no AGI limit for conversion.
Customer: replied 1 year ago.

MY REPLY


You wrote: So - her only option is to make nondeductible contribution to the traditional IRA.


However - after making IRA contribution - she may convert funds from traditional to Roth IRA - there is no AGI limit for conversion.


 


I agree with you that beginning in 2010 with the year 2010, there is no restriction income or filing against converting to a Roth IRA. But it is based on filing status and income. As I mention earlier my friend is single and her income is over 125,000. Based on previous correspondence she is not allowed to have a Roth IRA ,or contribute any amount to Roth Ira either directly or by conversion to begin with.


The tricky part is figuring out (1) what the tax cost of converting to a Roth will be, (2) whether converting to a Roth will save or cost you money over the long-run, (3) whether it makes sense to take advantage of the government's one-time only offer to spread the cost of a Roth conversion over two years, and (4) how much to convert.


I recommend that you read http://taxes.about.com/od/retirementtaxes/a/Roth-IRA-Conversions_2.htm


 


BTW: Interestingly enough my first name is Zev

Expert:  Lev replied 1 year ago.
As I mention earlier my friend is single and her income is over 125,000. Based on previous correspondence she is not allowed to have a Roth IRA ,or contribute any amount to Roth Ira either directly or by conversion to begin with.
You are correct that she is not allowed to make Roth IRA contributions because of AGI limitations. But because there is no AGI limitation - she is allowed to convert into Roth IRA funds previously contributed to the traditional IRA. There is no income limits on conversions.

I personally prefer Roth IRA because of some advantages - mainly - earnings will be never taxable AND - there will not be RMD after age 70 1/2.
You have a valid point that if she has both deductible and nondeductible IRAs - she would not be able to separate them for conversion purposes - and converted amount will include both taxable and not taxable portions. That is because taxable portion in case on conversion is determined the same way as for distribution purposes.
However - assuming she will be taxed on distribution anyway - conversion might be beneficial in sense to avoid tax liability on earnings.

Spreading tax liability from conversion was only allowed in 2010 - that option is not available anymore.
How much to convert depends on current and prospective taxable income.
There are other issues to consider - for instance if the person receives social security - part of it might be taxable - so additional taxable income might trigger additional social security benefits to be included into taxable income. In this case we might plan larger conversion in the year before starting social security benefits.
You have a very valid point - but as we see such planning is very specific to individual circumstances.

There is a good point in the referenced article about isolating nondeductible IRA funds - however most 401k and 403b plans do not accept funds from IRA. But the idea is nice and definitely worth to try.

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