Now Is a Good Time for Employees to Make Their 2022 IRA Contributions If They Have Not Already Done So
Ed Zurndorfer –
An individual retirement arrangement (IRA) provides a tax-beneficial way in which an individual can set aside additional money for his or her retirement years to help pay expenses incurred during retirement. An IRA may be either an individual retirement account that the IRA owner establishes with a financial services company (such as a bank, a credit union, or a brokerage firm) or an individual retirement annuity that the IRA owner establishes with an insurance company. IRAs can be broken down into two types – traditional and Roth.
The one requirement for an individual to contribute to any type of IRA in any year is that the individual (or a spouse if married) must have some type of earned income (compensation) during that year. Compensation includes:
- (1) Wages or salary;
- (2) Commissions;
- (3) Net self-employment income;
- (4) Alimony (but only with respect to divorce and separate instruments executed before January 1, 2019);
- (5) Nontaxable combat pay earned by Uniform Service members; and
- (6) Taxable nontuition fellowship/stipend payments.
Federal employees will receive from their agencies sometime during January 2023 their 2022 W-2 statements. The W-2 statement shows the amount of compensation (salary) the employee earned during 2022. All employees (and spouses if an employee is married) are therefore eligible to contribute to either a traditional IRA and/or to a Roth IRA for calendar year 2022. The deadline for making 2022 IRA contributions is the 2022 federal income tax filing deadline of April 18, 2023. The April 18,2023 deadline for making 2022 IRA contributions is the case even if an employee applies for a 6-month 2022 federal income tax filing extension.
This column discusses the rules for federal employees for making 2022 contributions to the three types of IRA, namely a:
- (1) Traditional “deductible” IRA;
- (2) Traditional “nondeductible” IRA; and a
- (3) Roth IRA.
The type of IRA that an individual is eligible to contribute to depends on two factors: (a) Whether the individual is covered by an employer-sponsored defined benefit plan (such as a CSRS or a FERS pension) or participates in an employer-sponsored defined contribution plan) (such as a 401(k), 403(b); or the Thrift Savings Plan and (b) The amount of an individual’s modified adjusted gross income (MAGI). Since all permanent federal employees are covered by either the Civil Service Retirement System (CSRS) or the Federal Employment Retirement System (FERS), the issue of what type of IRA a federal employee can contribute to for the year 2022 will be determined by an employee’s 2022 MAGI.
In addition to receiving their 2022 W-2 statements during January 2023, employees will also receive other tax-related statements for 2022 (including a 1099-INT, 1099-DIV, 1099-B, 1099-MISC, and 1099-NEC). This means that by early to mid-February most employees will know the amount of their 2022 gross income and therefore will be able to determine their 2022 MAGI. At that point, they should be able to determine what type of IRA they are eligible to contribute to for the year 2022.
For the year 2022, all federal employees can contribute a maximum $6,000 to a traditional, to a Roth IRA, or to a combination of both. Those employees who were over age 49 during 2022 (these employees born before January 1, 1973) can contribute an additional $1,000 in “catch-up” contributions to an IRA for the year 2022. Note that an individual’s combined traditional IRA and Roth IRA cannot exceed $6,000 (under age 50) or $7,000 (over age 49) for the year 2022.
Traditional “Deductible” IRA
If an individual (or his or her spouse) is covered by and participating in an employer-sponsored retirement plan, the individual may not be able to deduct some or all of the amount of their traditional IRA contribution on their federal income tax return (as an adjustment to income). The contribution amount is entered on Form 1040, Schedule 1 (Part II Adjustments to Income, line 20). A portion of the 2022 Form 1040, Schedule 1 (Part II Adjustments to Income) is presented here:
The deductible amount begins to decrease (“phase out”) when the traditional IRA owner’s MAGI increases above a minimum amount (“lower threshold”) and is eliminated altogether when MAGI reaches a maximum amount (“upper threshold”). Table 1 below summarizes the deductibility of traditional IRA contributions for individuals (or spouses) covered by an employer-sponsored retirement plan during 2022. Note that all permanent federal employees are covered by a retirement plan (either a CSRS annuity pension or a FERS annuity pension, and all employees are eligible to contribute to the Thrift Savings Plan). Table 1 applies to federal employees who are considering making contributions to a traditional IRA for the year 2022. When federal employees receive their 2022 W-2 statement in January, they should note on their W-2 Box 13 “Retirement Plan” box will be checked.
Table 1. Deductibility of IRA Contributions-Individual (or Spouse) Covered by Employer Retirement Plan* for the Year 2022
|Filing Status||Modified AGI (MAGI)**||Deduction|
|Single or Head of Household||$68,000 or less $68,001 – $ 77,999 $78,000 or more||Full Partial*** None|
|Married Filing Joint (Spouse Covered) or Qualified Widow||$109,000 or less $109,001 – $128,999 $129,000 or more||Full Partial*** None|
|Married Filing Joint (Spouse Not Covered)||$204,000 or less $204,001 – $213,999 $214,000 or more||Full Partial*** None|
|Married Filing Separate (Covered or Noncovered Spouse)||Less than $10,000 $10,000 or more||Partial*** None|
*As shown on an employee’s W-2 Statement Box 13 (with a “X” in the box)
**Modified AGI is equal to Adjusted Gross Income (AGI) plus student loan interest deduction plus foreign earned income exclusion plus foreign housing exclusion or deduction plus excluded US savings bond interest shown on Form 8815 plus Excluded employer provided adoption benefits shown on Form 8839.
***Individuals whose MAGI is within the phase-out (partial deduction) range should use the “Deduction for Traditional IRA Contribution Worksheet” found in IRA Publication 590-A (https://www.irs.gov/pub/irs-pdf/p590a.pdf).
The following example illustrates:
Example. Thomas is a federal employee and is married to Julie. They are both 40 years old. Julie is employed part-time in private industry but is not covered by a retirement plan. Their combined MAGI for 2022 is $113,000. Thomas’ salary is $75,000 and he contributed $6,000 to his traditional IRA for 2022. Since Thomas’ and Julie’s MAGI is between $109,000 and $129,000 and Thomas is covered by a retirement plan (FERS), Thomas’ and Julie’s IRA contributions are subject to the deduction phase-out as follows:
- End of Thomas’ and Julie’s phase-out retirement ……………………………………… $129,000
- Thomas’ MAGI per his joint return with Julie ……………………………………………..(113,000)
- Subtract line 2 from line 1 …………………………………………………………………………..16,000
- Multiplied by 30% ($6,000 maximum deduction)
- divided by $20,000 phase-out range) ……………………………………………………………..4,800
- Thomas’ 2022 Salary …………………………………………………………………………………..75,000
- Limit on IRA deduction (lesser of line 4 or line 5) ……………………………………….$4,800
Thomas and Julie can each deduct on their 2022 federal income tax return $4,800 of their $6,000 traditional IRA contributions. The amount that each cannot deduct ($1,200) is considered a nondeductible contribution.
Traditional “Nondeductible” IRA
Any individual who has earned income (or married and the individual’s spouse has earned income) is allowed to contribute the full amount to a traditional “nondeductible” IRA. It makes no difference with respect to the individual’s age or MAGI – the individual is allowed to contribute to a traditional nondeductible IRA provided the individual (or the individual’s spouse has earned income during the year for which the IRA contribution is made). This means that all federal employees (and spouses) are allowed to contribute the maximum possible to a traditional “nondeductible” IRA for the year 2022. Note that as a result of the passage of the SECURE Act 1.0 in December 2019, effective January 1,2020 all individuals (no matter their age) with earned income can contribute to a traditional nondeductible IRA. Prior to January 1,2020 (pre-SECURE Act), once an individual reached the year he or she becomes age 70.5, the individual could not contribute to a traditional IRA (either a deductible or a nondeductible traditional IRA). Effective January 1,2020, there is no age limitation for contributing to a traditional IRA (either a “deductible” or a “nondeductible” traditional IRA).
Reporting Traditional Nondeductible Contributions IRS Form 8606 (Nondeductible IRAs) must be filed to designate 2022 IRA contributions as nondeductible. Individuals do not designate their contribution as nondeductible until they file their 2022 income tax return. This means that federal employees who make contribution to traditional nondeductible IRAs for the year 2022 must include as part of their 2022 federal income tax return IRS Form 8606 in which they will report the amount of their contribution. A portion of the 2022 Form 8606 is presented here:
By reporting their nondeductible contributions on Form 8606, employees are establishing a “cost basis” in their traditional IRA. In establishing a “cost basis” in their traditional IRA, the IRA owner will not be taxed on the entire amount of the IRA when it is withdrawn. When the traditional nondeductible IRA is withdrawn, only the accrued earnings will be subject to federal and state income taxes. This is because since the contributions were made with after-taxed dollars (as reposted on Form 8606), the contributions will not be taxed again when they are withdrawn. Note that if an individual does not file Form 8606 in any year that the individual made a nondeductible contribution to a traditional IRA, that when the individual eventually withdraws that contribution from the IRA, the contribution will be taxed.
A Roth IRA is an individual retirement account in which contributions are always nondeductible. Roth IRAs like traditional IRAs accrue earnings. The difference between traditional IRAs and Roth IRAs is with respect to withdrawals. With a traditional IRA, at least the accrued earnings portion of the IRA will be taxable when withdrawn. With a Roth IRA, all qualified withdrawals will be tax-free, including the accrued earnings. A qualified Roth IRA withdrawal means that the Roth IRA owner has fulfilled two requirements, namely: (1) At the time of withdrawal, the Roth IRA owner is at least age 59.5; and (2) It has been at least 5 years since January 1 of the year the Roth IRA owner made his or her first Roth IRA contribution.
The Roth IRA has no minimum or maximum age contribution restrictions. There are no “other retirement plan” participation restrictions or rules. Contribution limits for 2022 are $6,000 for all individuals with earned income and $7,000 for individuals with earned income and who were over age 49 as of Dec. 31, 2022 (individuals born before Jan. 1, 1973). But there are annual modified adjusted gross income (MAGI) limitations for making Roth IRA contributions. The 2022 MAGI limitations are presented in Table 2:
Table 2. Roth IRA Contribution Phase-Out (2022)
|Filing Status||Modified AGI* Phase-Out Range*|
|Married Filing Jointly or Qualified Widow(er)||$204,000 – $213,999|
|Single, Head of Household||$129,000 – $143,999|
|Married Filing Separate1||$0 – $10,000|
1 Individuals Filing Married Filing Separate who did not live with their spouse at any time during the year are treated as single.
*Modified AGI for Roth IRA Contribution equals: Adjusted Gross Income less income from Roth IRA conversions less income from Roth IRA rollovers from employer retirement plans plus deduction from traditional IRA contribution plus student loan interest deduction plus foreign earned income exclusion plus foreign housing exclusion or deduction plus exclusion of qualified US Savings Bonds interest used for exclusion₊ Exclusion of employer-provided adoption benefits
No IRS forms have to be filed in the year contributions are made to a Roth IRA. Also, no IRS forms have to be filed in the year qualified withdrawals are made from a Roth IRA.
Summary of the Major Differences Among IRAs
Table 3 presents a summary of the major differences among a traditional deductible IRA, a traditional nondeductible IRA, and a Roth IRA.
Table 3. Comparison of Roth IRA, Traditional Nondeductible IRA and Traditional Deductible IRA
|General Characteristics||Roth IRA||Traditional Nondeductible IRA||Traditional Deductible IRA|
|Are contributions deductible?||No||No||Yes1|
|Are distributions taxable?||No2||Yes, to the extent they exceed “basis”||Yes|
|How is “basis” allocated to distributions?||Basis in all Roth IRAs distributed before earnings||A portion of total basis is allocated to each distribution||Basis is $0; therefore, distributions are fully taxable.|
|Are distributions required during IRA owner’s lifetime? (Required Minimum Distributions)||No||Yes, starting for the year the IRA owner reaches his or her required beginning date||Yes, starting for the year the IRA owner reaches his or her required beginning date|
1 The amount of the deduction may be “phased out” for a traditional IRA owner (or their spouse) who is covered by an employer-sponsored retirement plan.
2 Assuming it is a “qualified” Roth IRA distribution.
3 SECURE Act 1.0 changed the required beginning date (RBD) from age 70.5 years old to age 72 years old for individuals born after June 30, 1949. SECURE Act 2.0 changed the RBD to age 73 for individuals born after December 31,1950 and before January 1,1958 and age 75 for individuals born after December 31, 1957. Individuals born before July 1,1949 are subject to RMDs upon reaching age 70.5.
Finally, during the period January 1 through March 31,2023 as federal employees are getting prepared to file their 2022 federal income tax returns, this is a suitable time for employees to make their 2022 IRA contributions if they have not already done so. This is because employees will have determined during this period what their 2022 MAGI is and therefore which type of IRA they are eligible to contribute to. The deadline to make their 2022 IRA contributions is April 18, 2023, even if they file for a six months 2022 federal income tax filing extension. Employees who make their 2022 IRA contributions before April 18,2023 are advised to make sure that they mention to their IRA custodians that their contributions are for calendar year 2022. Otherwise, an IRA custodian could assume that the contributions are calendar year 2023 due to the fact that the contributions are being made during calendar year 2023.
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Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.