Are IRA contributions tax-deductible?
Well, yes and no. If you qualify, then yes they are. However, if you are putting contributions into a Roth IRA, or another non-traditional IRA, you will not qualify for a tax deduction.
In this article, we will be talking about traditional IRAs and what it takes to qualify for the tax deductibles.
There are a few caveats that will prevent IRA contributions from being tax-deductible. This will include how much you earn, your retirement plan status, and your marriage status among other things.
We’ll get into more detail now, let’s get started!
What Are IRA Contributions?
Let’s go back to the real basics here. An IRA contribution is money that you put into a traditional, Roth or another type of IRA which allows you to save up for retirement.
There are usually annual limits on how much you can put towards an IRA, with some of those contributions potentially being tax-deductible. This will depend on the account owners’ income and their employment.
IRA stands for individual retirement arrangement. An IRA contribution simply refers to the money that you as an individual deposit towards your retirement arrangement.
IRAs are designed so that people can build up the security of an amount of money that they can spend during their retirement.
There are two main types of IRA- traditional IRA or Roth.
Traditional IRA is specifically designed for tax-deferred savings.
Therefore, contributions made could be tax-deductible and your investments can slowly grow without having to pay capital gains or dividends taxes on an annual basis as you would normally if they weren’t in an IRA account.
Roth IRA is on the other hand and means that you don’t get an immediate tax break but when you are at retirement age, you can withdraw your money without having to pay taxes.
This could be beneficial because you won’t have to constantly be worried about what the tax bracket will be at your age for retirement as you’ve already paid your taxes when you put your contributions into your IRA, to begin with.
Contributions to a traditional IRA are deductible within the tax year that they are paid in. You won’t owe taxes on these contributions or their investment returns until after you retire.
From the IRS’s point of view, your contributions to a traditional IRA reduce your overall taxable income for that year by that amount.
Are IRA Contributions Tax Deductible If I Have A Retirement Plan?
You may be able to claim a deduction on your individual federal income tax return on what you have contributed to your IRA depending on the IRA contribution limits.
If you have a retirement plan at work, your deductions could be limited. This could also be the case if a retirement plan at work covers your spouse (if you’re married).
If your income exceeds a certain level, you may also not be able to claim tax deductions on your IRA contributions.
The amounts on these deduction limits change every tax year and the IRS government page has up-to-date charts showing the income range in which your deduction for yourself or your spouse may be disallowed.
If you are within these limits, you can contribute up to $6,000 and you can deduct this from your savings. If you are age 50 or over and are just starting an IRA you can also add another $1000 which will be tax-deductible.
If you have no retirement plan at your workplace, you can deduct your contribution no matter what your income is.
However, if you have a higher income, these deductions for IRA contributions are limited if you or your married spouse has a retirement plan with work.
How Does An IRA Affect Taxable Income?
You can make your contributions with pre-tax dollars, therefore reducing your taxable income for the year.
Once invested, this will grow tax-free until you reach retirement age at which point you will be taxed on the amount distributed.
This gives you a tax break for the year that you put in your money but eventually, you have to pay that tax when you withdraw that money.
A Roth IRA is different in that this is funded with after-tax dollars before your retirement which has no impact whatsoever on your taxable income for the year.
But the upshot of this is that you won’t have to pay any taxes when you withdraw that money. This includes any tax-free growth that occurs whilst it’s in the account.
How Much Does Contribution To An IRA Reduce Taxes?
Probably more than you think. If you’re contributing to a traditional IRA you can save a pretty decent amount of money in your taxes.
For example, if you’re in the 32% tax bracket, you can make the full $6,000 contribution to your IRA and this would equate to having a thousand dollars off of your tax bill.
Contributions to a Roth IRA, on the other hand, are not tax-deductible and you don’t need to report those contributions on your tax return.
However, of course, your return of contributions is not subject to tax when you reach retirement which can be beneficial in the long term.
If you don’t report your Traditional IRA contributions for your non-deductibles, there is a penalty from the IRS.
The minimum penalty is a $50 charge, however, this can open you up to an audit if you don’t have a cause, and any further contributions will be treated as fully taxable instead of being able to be partially tax-free.
The bottom line is that if you are below this higher income level and you and your spouse don’t have another retirement account with your workplace, you can make the maximum yearly contribution to your IRA and the full amount will be tax-deductible.
However even if you don’t qualify for the tax deduction, you should still be trying to save for your retirement.
Even if you cannot deduct any or all of your IRA contributions, that investment will still be able to grow tax-free until your retirement age, so any additional money that you make off of your retirement investments is still going to be worth it in the long term and make far more sense than sitting in a bank account waiting for you to use it.