Can I Claim a Tax Deduction for Contributions by a Rollover to a Traditional IRA?
Original post by Mike Parker of Demand Media
A traditional individual retirement account (IRA) is a tax-advantaged investment account that allows taxpayers to set aside a portion of their earnings toward their retirement years. You can deduct qualified contributions to your traditional IRA from your income when you file your income tax return, and the funds in your IRA grow tax-deferred until you choose to withdraw them. You can also move funds from one qualified account into your traditional IRA through a process known as a rollover.
A traditional individual retirement account is, by definition, an individual account. It is set up by you and for your benefit. You can make direct contributions to your traditional IRA in the form of money, which is cash or cash equivalents. If you have another qualified retirement plan, such as an employer's qualified pension plan or even another IRA with a different trustee, you can do a trustee-to-trustee transfer. There are no tax consequences to this type of transaction because you never take possession of the funds. If you take possession of funds from a qualified plan you can still move those funds into your IRA without generating a taxable event by doing a rollover.
You must complete the rollover of any funds you received from a qualified plan into your traditional IRA within 60 days. If you do not complete the rollover within that time frame any funds you received will be subject to federal income taxes as ordinary income at your then current tax rate. If you are less than 59 1/2 years of age you will also be subject to a tax penalty of 10 percent of the amount received.
The Internal Revenue Service refers to a rollover as a tax-free distribution of assets from one qualified retirement plan to another qualified retirement plan. Contributions made to the original qualified retirement plan are typically made with pre-tax dollars, so no tax deduction is available when you roll these funds over into your current traditional IRA.
Qualified plan administrators are required to withhold 20 percent from all eligible rollover distributions for income tax purposes. You can avoid this withholding by electing to do a direct rollover. Instruct your original plan administrator to pay your distribution directly to your IRA. If any part of your distribution is paid to you, the plan administrator must withhold the 20 percent, and the amount withheld is considered taxable income. If you rollover the entire amount you received, you would still be liable for taxes on the 20 percent that was withheld.
- Charles Schwab: Rollover IRAs: Frequently Asked Questions
- Smart Money: Rolling Over Retirement Accounts
- Internal Revenue Service: Publication 590 Individual Retirement Arrangements, Rollovers
- Internal Revenue Service: Retirement Topics - Rollovers of Retirement Plan Distributions
About the Author
Mike Parker has been writing professionally for more than 15 years. His work has appeared in various print and online publications, including "Grassroots Music Magazine," "Christian Single Magazine," BuddyHollywood.com and Lifeway.com. He earned a Bachelor of Arts degree in bible from Hardin-Simmons University.