You may not be eligible — here are your options
Dear Dan,
I’m single, 46, and put the max $7,000 into my IRA in June, thinking I’d be able to deduct it. My tax program says the $120,000 I made in 2025 is too much to take the deduction and that I have to pull it out or pay a penalty. Is there any other option?
Out of Luck in Florida
Dear Out of Luck,
If you are covered by an employer retirement plan, the software is correct and you made too much to deduct the contribution. The phaseout range for deductibility for 2025 was a Modified Adjusted Gross Income of $79,000-$89,000. However, if you are not covered, there is no income limit for single taxpayers, and you should be able to take the deduction.
Check box 13 on your W-2 to see if it accurately reflects your status. Then check if that information was entered correctly in the software you use.
Let’s run through three options if you are not eligible to deduct the contribution: remove it, recharacterize it or leave it in the IRA.
If you remove the $7,000, you will have to pay taxes on any earnings the $7,000 made since being in the IRA. You may want to get help with the calculation from the IRA custodian or your tax adviser. This needs to be done by the extension deadline, Oct. 15, 2026, to avoid a possible penalty. (See Pub 590-A.)
If that $120,000 of income includes income from all sources and not just your job, your Modified Gross Income for 2025 is lower than $150,000 and you are eligible for a Roth IRA contribution. You cannot “recharacterize” (that’s tax talk for “undo”) a conversion to a Roth IRA but you can recharacterize a contribution made to a traditional IRA and direct those funds to a Roth IRA account.
You still do not get a tax deduction for making the $7,000 Roth IRA contribution, but future earnings will come to you tax-free if you don’t withdraw them from the Roth IRA before you turn 59½. If you need cash before then, you can pull the $7,000 out tax-free because the ordering rules allow you to take contributions out first and you already paid tax when the $7,000 was put in the Roth IRA.
Recharacterizing the contribution will not trigger taxes on any possible earnings on the contribution, but it must be done by Oct. 15, 2026.
If you leave it in the traditional IRA, you will want to make sure the software is not reducing your gross income by the $7,000 (look on Schedule 1) and that it creates a Form 8606. This form is used to track nondeductible contributions to an IRA. Keeping Form 8606 up-to-date assures that you do not pay tax on the $7,000 or any other nondeductible contributions again when you start to take distributions from the account.
Note that with traditional IRAs, you can’t just take the $7,000 out tax-free as you can with the Roth IRA. Every distribution from a traditional IRA is partially considered a return of nondeductible contributions, deductible contributions and earnings. The nondeductible portion is tax-free, but the rest is taxable as ordinary income. The pro-rata portion that is tax-free is calculated on Form 8606 every year a distribution is made, regardless of your age, as long as there are after-tax funds in any IRA you own.
None of the three options reduces your taxes in 2025. Of the three options, I favor recharacterizing the contribution and getting that money in a Roth IRA.
Choosing to remove it can trigger some taxes on the earnings and possibly a penalty and the money will stay in a taxable, nonretirement account. Leaving it in the traditional IRA means dealing with the infamous pro-rata rule via Form 8606 for as long as you have an IRA, and there will be future taxation on earnings.
By contrast, shifting the contribution to a Roth IRA will not cause any taxation if left alone until 59½, and can afford you some tax-free access before then if you need it.
If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line.
Originally published on MarketWatch. Read the original article here.