401k Eligibility for deductible IRA contribution

Submitted by Nick Pappas on Wed, 2022-03-16 13:07

A recent CFP exam question from a young advisor in our office has sparked a lot of conversation. Here is the scenario and we will ignore income limits since that is straight forward. Main focus is what is the definition of eligibility for being able to deduct an IRA contribution all other rules being met.

If your employer offers a 401k but you do not participate and no employer contributions are made of any kind, are you eligible to make a deductible IRA contribution to an IRA? Our understanding has always been that having it available disqualifies you from being able to make the D-IRA contribution but per the CFP question since no contributions of any kind were made to the 401k then the IRA contribution is deductible. (the persons income was stated as 1 million per year so no confusion from this standpoint)

We looked up the IRS definition of “Covered” and it does seem to read as you are not covered if no contributions are made to the plan.

As a hypothetical follow-up, assuming that is the case if a contribution was made in 2021 but none will be made in 2022 with the same employer are you still considered to be covered b/c of the 2021 contributions or is it based on each calendar year?

In almost every scenario thinkable the employee should be using the 401k instead of the IRA if match is involved but this question really caught our office off guard since we have always seen it written as “eligible” for 401k means no deductibility for IRA (if high income)

Thanks in advance for thoughts on this.
-Nick



Submitted by Alan - IRA critic on Wed, 2022-03-16 15:14

401(k), 403(b), Salary deferral SEP, SIMPLE IRA

“The individual is an active participant if the individual elects to defer compensation (make salary deferral contributions) to the  plan. If the individual is eligible to make salary deferral contributions, but declines to make such salary deferral contributions for a year, and no other contributions or forfeitures are allocated to such individual’s account for the plan year ending with or within the individual’s taxable year, the individual is not an active participant for that year.”

Submitted by William Tuttle on Wed, 2022-03-16 17:46

It is unfortunate that many people think being an eligible participant is sufficient and even the IRS uses the misleading term “covered” by an employer retirement plan. To be subject the traditional IRA deduction income limit.
As pointed out by Alan, the only correct measure/term is “active participant.” In the tax code and IRS regulations only an individual who makes or receives contributions is an active participant.
An individual is consider an active participant in an employer retirement plan (except a SEP IRA) in the tax year the contributions are for, regardless of what calendar year they are received.
In a SEP IRA, an individual is consider an active participant in an employer retirement plan in the calendar year the contributions are received, regardless of what tax year they are for.

Add new comment

Log in or register to post comments