Though all individual retirement plans (IRAs) offer tax benefits, not all contributions to IRAs can be deducted from your income taxes. Knowing the rules for figuring the amount of your IRA contribution deduction, and which accounts permit deductions for contributions, helps you decide which account type and contribution amount is right for you.
Traditional IRAs with No Employer Plan
If you cannot contribute to an employer-sponsored retirement plan, you can deduct your entire traditional IRA contribution up to the annual contribution limit regardless of your income level. If you are married, your spouse must also be unable to contribute to an employer plan for you to automatically be able to deduct your entire distribution. To claim the deduction, you must use either Form 1040 or Form 1040A to file your income taxes.
Traditional IRAs with an Employer Plan
If you or your spouse has an employer plan you can contribute to, such as a 401k, 403b or thrift savings plan, you may be limited in how much of your traditional IRA contribution you can deduct if your modified adjusted gross income is too high. Each year, the IRS adjusts the phaseout range and maximum income limits for each filing status. If you fall in the phaseout range, your deduction limit will be lower than your contribution limit. For example, if your contribution limit equals $5,000 but your deduction limit equals $3,000, the first $3,000 of your traditional IRA contribution can be deducted, but if you contribute over $3,000, you cannot deduct any more.
Calculating a Limited Deduction
To figure how much of your traditional IRA contribution you can deduct, subtract your modified adjusted gross income (MAGI) from the upper limit of the phaseout range. Multiply the result by 0.25 if you are married filing jointly or a qualifying widow(er) and under 50, 0.3 if you are married filing jointly or a qualifying widow(er) and 50 or older, 0.5 if you use any other status and are under 50 and 0.6 of you are any other status and 50 or older. Round the result to the next highest multiple of 10 or $200, whichever is greater, to find your maximum deduction. For example, $513 would round to $520 while $120 would round to $200.
When you make a contribution to a Roth IRA, none of the contribution can be deducted from your income taxes. Roth IRAs allow you to contribute after-tax dollars so that when you take qualified distributions, you can remove both the contributions and earnings without having to pay any further income taxes. Therefore, even though Roth IRAs do not offer an immediate tax benefit, you may save more in the longer run with a Roth IRA than a traditional IRA, especially if you think you will pay a higher tax rate when taking distributions than when making contributions.
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