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"Stealth" IRA Contributions

As we begin to prepare for tax season, IRA contributions are on the minds of many taxpayers.  This should be no surprise since not only do tax-deductible IRA contributions reduce current tax bills, but non-tax-deductible IRA contributions have the potential to reduce future tax bills as well.  With these tax benefits in mind, here are three ways to effectively increase your household's IRA contributions that often fly under the radar:            

1. Spousal IRA's

In general, a taxpayer must have taxable compensation (wages, salaries, self-employment income, etc.) to be able to contribute to his/her IRA.  One useful exception to this rule (that our household has taken advantage of in past years) is that a non-working spouse may "borrow" earned income from the working spouse for the purpose of making an IRA contribution.

A non-working spouse's traditional IRA contribution is also more likely to be tax-deductible than a working spouse's, i.e. the tax-deductibility phases out at a higher level of income.  And the original source of the money going into the "spousal IRA" is irrelevant - the working spouse could write the contribution check, or it could come as a gift from someone else.  (For more detail on spousal IRA's and other Ways in Which You May be Leaving Money on the Table, please visit the latest in our series of Articles on Wealth Management Topics.) 

2. IRA's for Children

A child may also open an IRA (or have one opened for them) if he/she generates qualifying earned income, say from babysitting, doing yard work, or walking neighborhood dogs.  Since current tax exposure is usually not a pressing issue for children, a Roth IRA is often the vehicle of choice in this instance.

And as with the "spousal IRA", the actual source of the contributed funds is irrelevant.  So little Johnny or Jane can spend all they make as they make it, and you or their grandparents can write the contribution check.  Johnny or Jane then benefit from decades of tax-deferred, compounding investment growth and hopefully pick up a little financial literacy in the process.  

This is an especially interesting strategy for small business owners who can legitimately hire their kids to shred documents, clean the office, answer phones, etc. The parents benefit from a legitimate business deduction, income is shifted to the child's lower tax bracket, and this also opens the door to their Roth contribution.

3. Paying for IRA Management Fees with Outside Funds

If you use "outside" funds (say, from a taxable or bank account) to pay fees for the management of a Rollover or Traditional IRA (or a retirement plan account for that matter), then under the Tax Cuts and Jobs Act (TCJA), it's no longer possible for those fees to be tax-deductible.  However, the main reason that we recommend that pre-retirement clients use outside funds for this purpose is to allow their tax-advantaged accounts to remain as large as possible and to grow as fast as possible.

These "outside" payments are not deemed by the IRS to be additional IRA contributions, but in effect, that's exactly the function they serve and the benefit they provide.  As a result, if you are currently incurring fees for the management of an IRA or retirement plan account, and if you are not paying these fees with outside funds, it's worth considering a change in that arrangement.

About the Author

Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.  

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