Can I Contribute to an IRA & Reduce My Federal Taxes?

by Mark Kennan

If you want to put aside money for retirement, the Internal Revenue Service gives you tax incentives to add to an Individual Retirement Account (IRA). The amount that your contribution saves you in the current year depends on your income-tax bracket and the type of IRA you choose.

Eligibile to Contribute

Eligibility to contribute to either a traditional or Roth IRA requires that you have taxable compensation, such as a salary or self-employment income, in an amount equal to or greater than the contribution you make. For a traditional IRA, you have to be younger than 70 1/2 years old at the end of the year. For Roth IRAs, your modified adjusted gross income must fall below the annual restrictions for your tax filing status. However, Roth IRA contributions cannot be deducted from your taxable income.

Nondeducitble Traditional IRA Contributions

Just because you can contribute to a traditional IRA does not guarantee that you can deduct your traditional IRA contributions. You can always deduct your traditional IRA contributions if you cannot contribute to a plan with your employer. If you, or your spouse, is covered, your modified adjusted gross income cannot exceed the annual limits. If your modified adjusted gross income does exceed the limits, you can still make a nondeductible contribution and the money will grow tax-free in the IRA.

Valuing your Traditional IRA Deduction

The amount that a traditional IRA contribution deduction saves on your taxes equals your tax bracket times your deductible contribution. For example if you fall in the 22 percent tax bracket and you contribute $2,000, you save $440 on your taxes. Even though it is easy to look just at the tax breaks for the current year, do remember that you will pay taxes on your traditional IRA distributions, while a Roth IRA will not require taxes on qualified distributions.

Claiming the Retirement Savings Credit

A contribution to a traditional IRA or Roth IRA qualifies you to claim the Retirement Savings Credit. However, the income restrictions limit who can claim the credit: singles making under $27,750, heads of household making under $41,625 and joint filers making under $55,500. In addition, you cannot be a full-time student during the year or be under 18. If you do qualify, the credit equals between 10 and 50 percent of your contribution, up to $1,000. When you file your taxes, attach Form 8880.

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