Latest Edition of the Tax Newsletter
Hi Former 15.518ers (plus some others) –
Less than a month until your tax returns are due! I spent most of last weekend getting mine (almost) done. What else happens on April 15, 2026? That is the deadline to contribute to an IRA for tax year 2025.
In my last edition, I covered the difference between a Traditional and a Roth Defined Contribution retirement plan (known as 401(k)s and 403(b)s). The tax issues are the same for Individual Retirement Accounts (IRAs) – you can have a Roth IRA (where you contribute after-tax dollars) or a Traditional IRA (where you contribute pre-tax dollars). One of the main differences relative to workplace 401(k)s and 403(b)s, is that the contribution limits are lower for IRAs.
For tax year 2025, the total combined IRA contribution limit is $7,000 for individuals under age 50. For those of us who are 50 or older, we can put in $8,000 (not $8,000 more, just $1,000 more, called a catch-up). These limits apply to both Traditional and Roth IRAs (and a taxpayer who puts some in each type is still limited to the $7K ($8K) in total). For tax year 2026, the contribution limits are $7,500 for individuals under age 50. Individuals aged 50 and older can contribute an additional $1,100 as a catch-up contribution (so in total, $8,600) for a 2026 contribution. You (or your spouse) must have earned income to contribute to an IRA. (Where this really applies for most people is 1) when you are a student with little-to-no earned income and 2) when you have kids, you cannot start saving for their retirement until they have earned income. I guess also the really wealthy who live off an allowance from their parents, but I am not worried about them!) Finally, as I mention above, contributions are due by the tax filing deadline, this year that is April 15, 2026.
There are also income limits. These are put in place so high-income taxpayers cannot save ‘too much’ and avoid ‘too many’ taxes via these tax-advantaged accounts. Fidelity has a good set of charts that shows all the limits (different tabs for Roth and Traditional). At a high level, for example, for a tax year 2025 contribution to a Traditional IRA if you are single and you are covered by a retirement plan at work, you cannot take any deduction for the IRA contribution if your income (your modified adjusted gross income-MAGI) is at or over $89,000 (and you cannot take the full deduction if your income is between $79,000 and $89,000). If you (or your spouse) are not covered by a retirement plan at work, then there is no income limit for taking a deduction for a contribution to a Traditional IRA (but, again you have to have enough earned income). For a Roth IRA, there is no distinction about being part of a workplace plan. In addition, note that the issue for a Roth is not whether or not you get a deduction, because there is no deduction with a Roth. The issue is whether or not you can even contribute to a Roth account. So, for example, a single taxpayer who wants to contribute to a Roth IRA can only do so if their MAGI is less than $165,000 for the tax year 2025 (and you cannot contribute the full amount if your MAGI is between $150K and $165K). The limits change every year and are different for taxpayers with a different filing status – all these are shown in the Fidelity chart linked above.
It is very important to also remember that even if you have income over the thresholds, you can still make non-deductible contributions to a Traditional IRA (same dollar limits on the contribution amount). You don’t get a deduction up front, but the earnings are tax deferred until you retire. Such non-deductible IRAs, as they are called, can be useful as they are, but they also open the door, namely the backdoor, for another saving option. In particular, what if you are over the income limit to contribute to a Roth IRA but you really want to save for retirement via a Roth IRA? Here is where the magic of the Backdoor Roth lies. To get around the income limits for the Roth, you first need to deposit your money into a non-deductible Traditional IRA account. Ideally you then wait a few days and rollover the assets from that account to a Roth IRA – known as a Roth conversion. There are no income limits on who can convert a Traditional to a Roth IRA. Whenever you convert a Traditional IRA to a Roth IRA there is a potential tax due because Traditional accounts are pre-tax dollars (we went over the decision for old IRAs in class, I am not going to cover again in this newsletter). But if you are doing this Backdoor Roth trick, normally there is no tax because you put after-tax dollars in the Traditional IRA and then almost immediately convert to a Roth. If you had a rise in the investment in the couple days before you convert, well, kudos to you, but there will be a tax. (I don’t really know if you need to wait a couple days or not. That is the conventional advice, but I have done it more quickly myself at times.) You may be wondering why we have to go through these gymnastics of opening one account and converting it, if it is widely known we can do this and many people do indeed do this. I think the income limits on the Roth IRAs are just political cover basically.
Some of you may be able to do what is known as a Mega-Backdoor Roth. This is where high-earners can avoid even more of the limits, legally. The government has threatened to put an end to these, but have not done so yet. I will cover these and SEP IRAs in my next edition.
In the meantime, here are some cool insights somewhat related to these topics from recent research at MIT Sloan.
In terms of investments in any of your savings accounts -- watch those fees! Recent research from one of my colleagues generated this graph.
Large Variation in Fund Fees for S&P 500 Funds
(y-axis is percent of funds; x-axis = basis points)
This is a graph of the funds (number of funds, not value-weighted) that hold the S&P 500, grouped by their fees in basis points (bps). The very left column indicates that roughly 20% of the funds have fees < 20 bps. But observe how many funds have fees greater than that – for holding the same bundle of assets! That will eat away at your returns. Pay attention to the fees.
Some other research from one of my finance colleagues shows that married couples do not optimize when selecting which retirement savings to maximize. For example, if spouse number 1’s employer matches a large amount and spouse number 2’s employer matches a small amount, the couple should first save in spouse number 1’s account and then if they still have enough to save more, start adding to spouse number 2’s account. The authors find, however, that 20% of couples make mistakes and save in the low-matched partner’s account. Of course, if you do not think you will stay married to the person, then you should indeed max your savings for yourself regardless of their employer match. This is what they find – couples who subsequently divorce lack coordination more often during marriage. Pick your partner wisely!
Think of your future self and save as much as you can for retirement (while still enjoying your youth!).
Michelle