Your eligibility to claim a deduction for your Traditional IRA contribution on your federal tax return depends on whether you are an active participant of an employer-sponsored plan in the year to which your deduction applies. If neither you nor your spouse is an active participant, you may deduct your full contribution for the year, up to the contribution limit . If, however, you are an active participant, your tax-filing status and modified adjusted gross income (MAGI) determine your eligibility to deduct your IRA contribution. Here we take a look at how to determine your active-participant status, which can be tricky as the rules vary for each type of employer-sponsored retirement plan. (see Traditional IRAs: Contributions.)

TUTORIAL: Traditional IRAs

W-2 Designation
If you are an active participant, your employer should indicate as such on your Form W-2 by checking the "retirement" box. However, administrative errors can happen, so this box is sometimes not checked even when it should be. It's helpful for you to understand the rules, so that you don't have to rely on your employer's reports to determine whether you are considered an active participant for a tax year.

Determining Active Status
The rules regarding active-participant status are different for different types of employer retirement plans. (For more, read 10 Most Overlooked Tax Deductions.)

Defined-Benefit Plan
If you are eligible to participate in a defined-benefit plan for the tax year, you are considered an active participant for that year. This is so even if you decline to participate in the plan, fail to make mandatory contributions to the plan or fail to perform the minimum service required to accrue a benefit under the plan for the year.

Money-Purchase Pension and Target-Benefit Plan
For money-purchase pension and target-benefit plans, you are considered an active participant for the year to which your contributions to these plans apply. This is so, regardless of when your contribution is actually deposited to your account.

For example, say your employer sponsors a money-purchase pension plan, and is required to contribute 10% of eligible compensation to the plan each year. Your employer has until its tax-filing deadline, including extensions, to deposit a particular year's contributions. So, if a 2012 contribution was made in 2013, you are considered an active participant for the 2012 tax year, the year to which the contribution applies.

Profit-Sharing Plans and SEP IRAs
With plans to which contributions are discretionary, such as profit-sharing plans and SEP IRAs, employees are considered active for the year in which the contributions are actually deposited to the employees' accounts - even if the contributions apply to the previous year. The reason for this rule is that it is usually impossible for employers to guarantee contributions to these plans for any particular year.

To demonstrate, let's say your employer sponsors a profit-sharing plan, to which it contributes 10% of eligible compensation for the 2012 tax year. But the contributions are deposited in 2013. Employees are considered active participants for 2013, the year in which the contributions are actually deposited to their accounts.

401(k) and 403(b) Plans
If you make salary-deferral contributions to a 401(k) or 403(b) plan, you are considered an active participant for the year to which your salary-deferral contributions apply. If you are eligible to make salary-deferral contributions but elect not to, you are not considered an active participant for that year.

Voluntary or Mandatory Contributions
You are considered an active participant for any year you make voluntary or mandatory contributions to an eligible employer-sponsored retirement plan. (A list of the eligible plans is here.)

Vesting Status Does Not Affect Active-Participant Status
Depending on the plan provisions, you may not be immediately vested in the year's contributions you receive from your employer. But your vesting status does not alter whether you are an active participant. This means that even if you leave that employer at a later date and you forfeit that non-vested contribution, you are still considered an active participant for the applicable year. (Read 10 Tax Benefits For The Self-Employed for more information.)

ABC Company contributes of 10% of its employees\' compensation to its money-purchase pension plan for the 2012 tax year. Under the provisions of the ABC money-purchase pension plan, employees\' contributions are 100% vested after working three years - no vesting occurs before then. Jane leaves ABC Company for a new firm after two years of employment.
Because Jane is leaving before she accrued any vested balance, she must forfeit the contributions that were made to her money-purchase-pension account at ABC Company. However, Jane is still considered an active participant for the 2012 tax year, because a required contribution was made to her money-purchase pension account.

If you and/or your spouse are active participants for a given year, you may need to perform a calculation to determine whether you are able to deduct your IRA contributions for that year. If you are not able to deduct the full amount, you may be able to deduct a portion, depending on your MAGI. This formula is explained in IRS Publication 590, available at Ultimately, you may want to consult with your tax professional for assistance with determining whether your IRA contribution is deductible.

Related Articles
  1. Retirement

    Using Your IRA to Invest in Property

    Explain how to use an IRA account to buy investment property.
  2. Retirement

    How a 401(k) Works After Retirement

    Find out how your 401(k) works after you retire, including when you are required to begin taking distributions and the tax impact of your withdrawals.
  3. Retirement

    Are Fees Depleting Your Retirement Savings?  

    Each retirement account will have a fee associated with it. The key is to lower these fees as much as possible to maximize your return.
  4. Retirement

    Retirement Tips for Doctors

    Learn five tips that can help physicians get back on schedule in terms of making financial preparations they need to retire.
  5. Investing Basics

    Do You Need More Than One Financial Advisor?

    Using more than one financial advisor for money management has its pros and cons.
  6. Insurance

    Cashing in Your Life Insurance Policy

    Tough times call for desperate measures, but is raiding your life insurance policy even worth considering?
  7. Retirement

    Is Netflix Stock Suitable for Your IRA or Roth IRA?

    Learn about the risks of Netflix's business plan and long-term corporate strategy, and see if the stock's risk/reward profile warrants inclusion in an IRA.
  8. Retirement

    Pros and Cons of Deferred Compensation Plans

    Learn about the pros and cons of non-qualified deferred compensation (NQDC) plans, including the flexibility of non-ERISA plans and the potential for forfeiture.
  9. Mutual Funds & ETFs

    The 8 Most Popular Vanguard Funds for a 401(k)

    Learn about some of the mutual funds in Vanguard's lineup that are popular among 401(k) investors, and find out why you should consider them.
  10. Retirement

    Is Caterpillar Stock Suitable for Your IRA or Roth IRA?

    Learn about Caterpillar's suitability for a retirement portfolio. Does CAT have long-term viability? Find out if CAT is better for a traditional IRA or Roth IRA.
  1. Can you have both a 401(k) and an IRA?

    Investors can have both a 401(k) and an individual retirement account (IRA) at the same time, and it is quite common to have ... Read Full Answer >>
  2. Are 401(k) contributions tax deductible?

    All contributions to qualified retirement plans such as 401(k)s reduce taxable income, which lowers the total taxes owed. ... Read Full Answer >>
  3. Are 401(k) rollovers taxable?

    401(k) rollovers are generally not taxable as long as the money goes into another qualifying plan, an individual retirement ... Read Full Answer >>
  4. Are catch-up contributions included in the 415 limit?

    Unlike regular employee deferrals, catch-up contributions are not included in the 415 limit. While there is an annual limit ... Read Full Answer >>
  5. Can catch-up contributions be matched?

    Depending on the terms of your plan, catch-up contributions you make to 401(k)s or other qualified retirement savings plans ... Read Full Answer >>
  6. Are catch-up contributions included in actual deferral percentage (ADP) testing?

    Though the Internal Revenue Service (IRS) carefully scrutinizes the contributions of highly compensated employees (HCEs) ... Read Full Answer >>

You May Also Like

Trading Center