Traditional IRA

A sole proprietor with earned income from their sole proprietorship can contribute to a Traditional IRA and receive a tax deduction provided they and their spouse is not covered by an employer sponsored retirement plan.

A sole proprietor may not be eligible to contribute to a Traditional IRA and get a tax deduction for the contribution if they (or their spouse) are covered by another retirement plan. Also, there are income limits that will determine whether a contribution is tax deductible. Note: To be considered covered by the IRS you don’t have to be a participant only eligible for an employer sponsored retirement plan. You’re considered 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.

Can I contribute to a Traditional IRA if I’m covered by a 401k plan at work?

Yes, you can contribute to a Traditional IRA even if you participate in an employer-sponsored retirement plan, however the contribution may not be tax deductible.

For 2020, the Traditional IRA limit is $6,000 and $7,000 if you are 50 or older.

If you or your spouse is covered by an employer-sponsored retirement plan, and your income exceeds certain levels, you may not be able to deduct your entire contribution. See the discussion on the IRS website of IRA deduction limits. See Publication 590, Individual Retirement Arrangements (IRAs), for the IRA rules on who can contribute, what compensation to use, and when and how to make IRA contributions.

I am single and am not covered by a retirement plan at work. Is my Traditional IRA contribution 100% deductible?

Yes it is. In 2020 you can contribute into a Traditional IRA up to $6,000 ($7,000 if you are 50 or older) and it is 100% tax deductible.

I am married and I am not covered by a retirement plan at work and my spouse is also not covered by a retirement plan at work. Is my Traditional IRA contribution 100% deductible?

Yes it is. In 2020 you can contribute into a Traditional IRA up to $6,000 ($7,000 if you are 50 or older) and it is 100% tax deductible.

I am single and I am covered by a retirement plan at work. Is my Traditional IRA contribution 100% deductible?

Maybe. It depends on your modified Adjusted Gross Income (MAGI).

$65,000 or less. A full deduction up to the IRA contribution limit.
More than $65,000 but less than $75,000. A partial deduction.
$75,000 or more. No deduction.
NOTE: If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined as Single filing status.

I am married and I am not covered by a retirement plan at work, but my spouse is covered by a retirement plan at work. Is my Traditional IRA contribution 100% deductible?

Maybe. It depends on your modified Adjusted Gross Income (MAGI). The chart shows the income range in which your deduction may be disallowed if you or your spouse is covered by a retirement plan at work.

Married filing jointly or qualifying widow(er) $104,000 or less. A full deduction up to the IRA contribution limit.
More than $104,000 but less than $124,000. A partial deduction.
$124,000 or more. No deduction.
Married filing separately Less than $10,000. A partial deduction.
$10,000 or more. No deduction.

What is a Traditional IRA?

A Traditional IRA (Individual Retirement Account) is a personal savings plan that gives you tax advantages for setting aside money for retirement. The 2020 Traditional IRA contribution limit is $6,000 or $7,000 for those age 50 or older.

Some of the investments that may be selected inside a Traditional IRA are mutual funds, annuities, stocks, bonds and CDs.

What are the benefits of a Traditional IRA?

For many investors, contributions to a Traditional IRA are tax-deductible from federal income taxes and also tax-deductible from state income taxes in most states.

A Traditional IRA allows your assets to grow tax-deferred, meaning you won't pay taxes on the dividends and investment earnings until you withdraw the assets. Tax deferred earnings growth can have a powerful effect over time.

Who can contribute to a Traditional IRA?

Business owners, self employed, independent contractors, employees who do not have retirement plans through their employer and non-working spouses. Investors who participate in an employer sponsor retirement plan such as a 401k can also contribute to a Traditional IRA. However the contribution may not be tax deductible depending on your income.

What are the disadvantages of a Traditional IRA?

Low maximum contributions. Business owners, self employed individuals and independent contractors who would like to make greater retirement contributions may want to research an Individual 401k or a SEP IRA.

When can I withdraw assets from my Traditional IRA?

Money can be withdrawn from a Traditional IRA after age 59 ½ although you will pay regular income taxes on your distributions. If you should withdraw money prior to age 59 ½ you will incur an additional 10% penalty. For most investors saving for retirement in a Traditional IRA is advantageous. During your higher tax bracket working years you are able to get a tax deduction on your annual contributions, and earn many years of tax deferred growth on your dividends and investment earnings. Once retired and usually in a lower tax bracket you can withdraw the money as needed from your Traditional IRA.

Can I withdraw from my Traditional IRA and avoid the 10% penalty?

There are several exceptions when you could withdraw money prior to age 59 ½ rule and not incur a 10% penalty, and they are as follows:

  • You have non-reimbursed medical expenses that are more than 10% of AGI or 7.5% of  AGI if age 65 or older.
  • You are disabled.
  • You are the beneficiary of a deceased IRA owner.
  • You are receiving substantially equal distributions according to IRS rule 72t.
  • The distributions are for qualified higher educational expenses.
  • The distributions are used to buy or build a first home ($10,000 maximum distribution).

When must I take distributions from my Traditional IRA?

Minimum distributions are required by the IRS according to a specific formula once you reach age 70 ½.

Note: Individuals may not be eligible to contribute to a Traditional IRA depending on an individual's income and depending on whether he or she participates in an employer sponsored retirement plan such as a 401k.

Many sole proprietors can’t deduct their Traditional IRA contribution due to Traditional IRA rules regarding income limits. Fortunately, the Individual 401k, SEP IRA, Defined Benefit Plan and SIMPLE IRA are available to sole proprietors and have significantly higher annual contribution limits. Learn more about these retirement plans available to a Sole Proprietorship.


Need Help or Advice?

Eric Kuniholm Eric Kuniholm, CPWA®
Certified Private Wealth Advisor®
Beacon Capital Management Advisors
President

If you have questions and need advice contact us. Beacon Capital Management Advisors is registered in all 50 States and is an Accredited Business of the Better Business Bureau since 2004. FINRA’s BrokerCheck.

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