Employees commonly use employer-sponsored 401K plans as a retirement investment vehicle -- this type of plan allows you to invest in a variety of stocks, bonds and mutual funds to maintain a balanced portfolio. If you do not have access to a 401K plan, you can still build a diverse portfolio with an Individual Retirement Agreement, or IRA. Unlike a 401K plan, contributions to an IRA are usually not made on a pre-tax basis. However, in some cases, you can use IRA contributions to reduce your federal tax liability.
If you choose a traditional IRA account, you may deduct the amounts you contribute to this retirement savings plan from your taxes for the year in which you made the contributions. For example, if you contribute $1,000 to your traditional IRA over the course of a year, you may claim a $1,000 deduction to reduce your tax liabilities for that year.
A Roth IRA differs from a traditional IRA because you realize the tax savings when you begin receiving distributions, rather than when you deposit funds into the account. You typically cannot claim contributions to a Roth IRA as a deduction to reduce your tax liability for the year in which you made the contributions.
The Internal Revenue Service (IRS) places limitations on your ability to claim contributions to a traditional IRA as a deduction from your federal tax liability. As of the date of publication, if only your spouse contributes to an employer-sponsored retirement plan, and you file jointly with your spouse, you can only claim a deduction if your adjusted gross income is less than $179,000. If you participate in an employer-sponsored retirement plan and file jointly with your spouse, the IRS begins phasing out your IRA tax deduction if your AGI exceeds $90,000. The IRS begins phasing out IRA deductions for single heads of household at $56,000 AGI.
You can only contribute to a traditional IRA plan until you reach age 70.5 -- after you reach this age, you must begin receiving distributions. Also, if you are younger than 50 years of age, you may only contribute up to $5,000 per year to your IRA, and $6,000 per year if you are age 50 or older. If you own more than one traditional IRA account, the limit applies collectively to all of your accounts. A Roth IRA does not impose the same restrictions.
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