There are two types of individual retirement accounts, or IRAs, one of which lowers your taxable income, and one of which does not. In addition, if you run a small business or are self-employed, you may be able to set up a Simplified Employee Pension IRA, which is technically an employer sponsored plan and tax-deductible. Depending on your income level, contributions to a Roth IRA, which are usually made after-tax, may result in a tax credit.
Deductible contributions to a traditional IRA come out of your income before you figure out your adjusted gross income. You don't have to itemize deductions or fill out Schedule A to lower your income with a traditional IRA contribution. The amount of your traditional IRA contribution that you can deduct from your income depends on whether you are married or single, whether or not you have a retirement plan at your job and the amount of your adjusted gross income.
Traditional IRA Limits
You can contribute $5,000 per year to your IRA, as of 2011, if you are under age 50, and up to $6,000 if you are over age 50. If you earn less than $5,000 per year, you can only contribute up to the total amount you earn in a year. You can earn up to $56,000 per year if you are single and covered by a retirement plan at work and still deduct up to the full $5,000 contribution. If you earn more than $66,000 as of 2011, are single and are covered by an employer plan, your traditional IRA contribution will not lower your taxable income at all. The allowable income is higher for married couples who file jointly.
Roth IRAs and the Retirement Savings Credit
Although contributions to Roth IRAs are made after you've paid the tax on your income, you may qualify for a tax credit if you've contributed to an IRA and earn less than a certain amount of money. A tax credit doesn't lower your taxable income, it lowers the amount of tax you will owe. If you are single, you can earn up to $27,750 to qualify for the credit as of 2011. Married couples who file jointly can earn up to $55,500. Depending on your income, between 10 and 50 percent of your IRA contribution could be credited against your taxes.
SEP IRAs operate differently from traditional or Roth IRAs, since the employer contributes to them, not the employee. In the case of self-employed people, the employer and employee are the same, so you can contribute to your own SEP IRA if you're self-employed. You can deduct contributions to SEP-IRAs on line 28 of form 1040. The amount you can contribute to the IRAs is up to 25 percent of each employee's compensation or up to $49,000 total as of 2011.
- IRS; Publication 590: Traditional IRAs: Figuring Your IRA Deduction; 2010
- Bankrate; Traditional IRAs Make Tax Sense for Some Filers; Kay Bell; 2008
- IRS; Get Credit For Your Retirement Savings Contributions; 2011
- IRS; Publication 560: Simplified Employee Pensions; 2010
- Dept. of Labor: SEP Retirement Plans for Small Businesses
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