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February 26, 2009

Tips for IRA Season


by Denise Appleby, CISP, CRC,CRPS, CRSP, APA

During the first few months of the year, many taxpayers will be looking for ways to reduce their tax burden for the previous year, and also take advantage of tax benefits where possible. Receiving the maximum possible benefits requires some diligence, such as making sure any IRA contributions are made to the right type of account, and also ensuring other transactions are processed correctly. Let’s review some tips that can be helpful to taxpayers. 

Indicate Tax Year on IRA Contributions

Posting a contribution for the wrong tax year is one of the most common mistakes made with IRA transactions. This typically occurs when contributions are received during the first few months of the year, and no tax year is indicated on the check. To prevent this potential error from occurring, IRA owners must clearly indicate the tax year to which the contribution applies on the face of the check, or include the year with ( or within) instructions to move funds from a non-IRA account.

IRA custodians usually deposit and report IRA contributions for the year received, unless the contribution is eligible to be applied to another year, and it is clearly indicated that the contribution applies to that (other) year. For financial professionals, making the extra effort to ensure clients indicate the tax year to which contribution applies, helps to avoid any re-work and aggravation that may arise from contributions booked for the wrong tax year.

Use Tax Refund to Fund IRAs

Individuals can now use their tax refunds to make IRA contributions VIA direct deposit. Those who want to split their contributions between multiple accounts must file IRS Form 8888. Otherwise, the deposit is indicated on the individual’s tax return.  

Since direct deposits will be automatically treated as contributions for the year they are received by the custodian, individuals who want these amounts to be treated as contributions for the previous year should provide the IRA custodian with instructions to make the necessary adjustments. The option to apply contributions to the previous year applies only to amounts that are credited to the IRA by April 15. Finally, individuals should ensure the IRAs are established before the deposits are sent to the custodian. 

Maximize Contributions 


Individuals, who did not contribute the maximum permissible amount to their IRAs during the previous year, still have the opportunity to do so-up to April 15 of the current year. For individuals who are eligible to receive a tax deduction for their contributions and/or receive Saver’s Credit, the benefits of making an IRA contribution can be significant. These include:

  • Tax-deferred growth on earnings (tax-free for Roth IRAs), and the compound effect of earnings on earnings.
  • Tax-deduction for contributions
  • Non-refundable tax-credit for individuals eligible for the saver’s credit.

With the deduction and the Saver’s credit, a contribution of $1,000 can cost the individual much less (than $1,000). For the fundamentals of contributing to an IRA, including contribution limits, see the article, IRA Contributions- Back to Basics  

SEP IRA (Employer Plan)

Small businesses can shelter up to $53,000 from taxes  by contributing that amount to a retirement plan. For those who operate on a calendar year, and missed the December 31 deadline to establish a qualified plan, a SEP IRA can be established by their tax filing deadline, including extensions. For an overview of SEP IRAs, see SEP IRAs- A Low Cost Retirement Plan for Small Businesses

Check Statements for Accuracy

Unfortunately, errors sometimes occur with retirement account transactions. Many of these can be corrected, and penalties avoided if they are detected early. Financial institutions may be more willing to correct certain errors, if they are brought to their attention before they file their reports with the IRS. The following are some statements that can be reviewed: 

  • Account statements: These are usually issued at least quarterly, and the final statement issued for the year will likely include a total of the contributions and distributions for the year. These can be reviewed to ensure transactions were posted correctly
  • 1099-Rs are required to be issued by January 31, to show distributions and recharacterizations that occurred from the retirement account during the year. These should be checked to ensure that:
    • The correct amounts are reported
    • The correct code is reflected in Box 7, and
    • The correct ‘taxable amount’ is indicated.
  • FMV Statement:  IRA custodians must provide owners of Traditional IRA, SEP IRA, SIMPLE IRA and Roth IRA with a written statement of their December 31 fair market value (FMV) by January 31. These should be checked to determine if there are unusual discrepancies in the FMV, which could occur if a rollover contribution or transfer was not posted to the intended account, or the wrong type of account was transferred to the receiving account. 

For statements that are required to be delivered by January 31 ( or the next business day if January 31 falls on a weekend or legal holiday), sufficient time should be allowed for delivery by first class mail. 

File IRS Form 8606 for Nondeductible Contributions

Individuals who make nondeductible contributions to traditional IRAs are required to file IRS Form 8606, to inform the IRS that the contribution is nondeductible. Form 8606 helps the individual to keep track of the basis created by the contribution, so as to prevent taxation of distribution of those amounts.  Failure to file Form 8606 will result in a penalty of $50 being owed to the IRS

Complete Recharacterizations Before Filing

Individuals often make Traditional IRA contributions throughout the year, in anticipation of their modified adjusted gross income ( MAGI) being within limits that permit a deduction, or for Roth IRAs, permit contributions. However, MAGIs can exceed these anticipated amounts for various reasons. Individuals, who find that their MAGI exceeds the limits for purposes of being eligible to make a Roth IRA contribution or claim a deduction for a traditional IRA contribution, may recharacterize that contribution. Recharacterizations are also completed simply because an individual wants to, usually because of preference of the features and benefits permitted for the type of contribution. For instance, an individual may be eligible to deduct a traditional IRA contribution, but may prefer the tax-free growth that is permitted for Roth IRA contributions. In such a case, if the contribution was made to a traditional IRA, the individual would recharacterize the contribution to a Roth IRA. The MAGI limits for IRA deductions and Roth IRA contributions are included in the article IRA Contributions- Back to Basics

Recharacterizations may be completed by the individual’s tax filing deadline including extensions. However, if the recharacterization is completed after the tax return has been filed, an amended tax return may be required. Accordingly, individuals may want to complete recharacterizations before filing their tax returns, in order to avoid the additional work and any accompanying costs. 

Provide All Related Paperwork to Tax Preparer

Information relating to distributions, contributions and reportable transactions for retirement accounts, are sometimes omitted from tax returns, because the tax preparer was unaware of the transactions. To prevent this from occurring, individuals should provide their tax preparers with any and all documentation they feel may include information about tax reportable activity that occurred for the tax year. Since Form 5498s are not required to be issued until the end of May, information relating to regular IRA contributions and rollover contributions should be documented and provided to the tax preparer. 

Coordinate and consult

One of the keys to having a successful IRA season is to ensure all stakeholders parties take an active part in ensuring that all bases are covered. This includes the IRA owner, the financial advisor and the tax professional. Individuals who are unsure of how IRA contributions would affect their tax owed or refund due may want to ask their tax professional to prepare a draft of two tax returns, one with the contributions and one without, so as to get an idea of the tax impact.  



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