Can You Use Pretax Dollars for an IRA?

by Deborah Barlowe

If a taxpayer satisfies certain criteria, the Internal Revenue Service allows him to contribute dollars to a traditional individual retirement account, or IRA, and to deduct that amount on his federal tax return. Some small companies also provide SIMPLE IRAs. If the person is eligible to participate in a SIMPLE IRA plan, the IRS permits him to place a portion of his compensation, pretax, into his SIMPLE IRA. The IRS taxes money the person contributes to either of these types of IRAs only when he withdraws funds from those accounts.

SIMPLE IRA Eligibility

The IRS considers a person eligible to participate in her employer’s SIMPLE IRA plan if she earned a minimum of $5,000 in at least one of the two years preceding her enrollment in the plan and if her employer anticipates paying her $5,000 or more in a year. Although the IRS requires an employer to make annual contributions to its SIMPLE IRA plan, the IRS allows an eligible employee to choose whether or not she participates in the plan. An employee participates in a SIMPLE IRA plan by electing to place a portion of her taxable pay into her SIMPLE IRA. Taxes are deferred until withdrawal.

SIMPLE IRA Contribution Limits

As of September 2011, the IRS permitted an eligible employee younger than 50 to place up to $11,500 of his compensation into his SIMPLE IRA. If the employee was 50 or older, he could defer up to $14,000 of his pay into his retirement account. If an employer chooses to make matching contributions to its SIMPLE IRA plan, the IRS generally requires the employer to contribute 3 percent of an employee’s pay or $245,000, whichever is less, into the IRA of each employees participating in the plan. An employer making non-elective contributions must contribute 2 percent of an employee’s first $245,000 of compensation into the accounts of everyone eligible to participate in the plan.

Traditional IRA Contribution Limits

If a taxpayer is younger than 70 1/2 and earns income during a year, the IRS permits her to contribute to a traditional IRA outside of her workplace. As of September 2011, a person younger than 50 could contribute the lesser of 100 percent of her compensation or $5,000 to her IRA in a single year. A worker who was 50 or older could contribute an additional $1,000 to her traditional IRA.

Deduction Limits

In general, a taxpayer can deduct, on his federal tax return, the amount he deposits in his traditional IRA. However, if his modified adjusted gross income exceeds certain thresholds determined by his tax filing status and by his or his wife’s participation in an employer-sponsored retirement plan, the IRS reduces or eliminates his ability to deduct his traditional IRA contributions. If a person participates in a work-sponsored retirement plan, for instance, the IRS allows him to deduct the full amount of his traditional IRA contribution only if the modified adjusted gross income on his tax return is $89,000 or less.

About the Author

Deborah Barlowe began writing professionally in 2010. With experience in earning securities and insurance licenses and having owned a successful business, her articles have focused predominantly on finance and entrepreneurship. Barlowe holds a bachelor’s degree in hotel administration from Cornell University.

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