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.)

Example
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.

Conclusion
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 http://www.irs.gov/. Ultimately, you may want to consult with your tax professional for assistance with determining whether your IRA contribution is deductible.

Related Articles
  1. Retirement

    Strategies for a Worry-Free Retirement

    Worried about retirement? Here are several strategies to greatly reduce the chance your nest egg will end up depleted.
  2. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  3. Professionals

    How to Build a Financial Plan for Gen X, Y Clients

    Retirement is creeping closer for clients in their 30s and 40s. It's a great segment for financial advisors to tap to build long-term client relationships.
  4. Professionals

    Don't Let Your Portfolio Be Trump'd by Illiquidity

    A look at Donald Trump's statement of finances and the biggest lesson every investor can learn.
  5. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  6. Retirement

    Maxing Out Your 401(k) Is Profitable: Here's Why

    It's shocking, but most American workers (73%) have no 401(k) retirement funds. Start saving now to anchor your retirement.
  7. Professionals

    Top Questions to Ask When Choosing a Robo-Advisor

    Think a robo-advisor might be the right choice for you? Be sure to ask these questions first.
  8. Professionals

    Top Retirement Hack? Start with a Lifestyle Change

    Instead of going through the usual retirement planning steps, some people are focusing on fostering a lower cost lifestyle from the start.
  9. Forex Education

    A Day In The Life of A Professional Forex Trader

    The professional forex trader lives an affluent lifestyle but pays the price with many hours of research and market watching.
  10. Insurance

    Picking the Best Longevity Insurance

    What you need to know before buying a "reverse life" policy.
RELATED TERMS
  1. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  2. See-Through Trust

    A trust that is treated as the beneficiary of an individual retirement ...
  3. Backdoor Roth IRA

    A method that taxpayers can use to place retirement savings in ...
  4. Current Service Benefit

    The amount of pension benefit accrued by an employee who had ...
  5. Self Invested Personal Pension ...

    A tax-efficient retirement savings account available in Great ...
  6. Elder Care

    Elder care, sometimes called elderly care, refers to services ...
RELATED FAQS
  1. Can you buy penny stocks in an IRA?

    It is possible to trade penny stocks through an individual retirement accounts, or IRA. However, penny stocks are generally ... Read Full Answer >>
  2. Can I use my IRA to pay for my college loans?

    If you are older than 59.5 and have been contributing to your IRA for more than five years, you may withdraw funds to pay ... Read Full Answer >>
  3. Can my IRA be used for college tuition?

    You can use your IRA to pay for college tuition even before you reach retirement age. In fact, your retirement savings can ... Read Full Answer >>
  4. Why are IRA, Roth IRAs and 401(k) contributions limited?

    Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy ... Read Full Answer >>
  5. How do you calculate penalties on an IRA or Roth IRA early withdrawal?

    With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the ... Read Full Answer >>
  6. What are the best ways to use your 401(k) without a penalty?

    The best way to use your 401(k) retirement savings account is to take normal distributions after you reach retirement age. ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!