Tax Break on IRA Deposits

by Herb Kirchhoff

To encourage wage earners to save for their retirement, Congress created Individual Retirement Arrangements, also known as Individual Retirement Accounts (IRA). The IRA law grants individuals a tax break on money they set aside for their retirement. The break is that income taxes on IRA contributions are deferred until you start taking money out of the IRA at retirement age, and each year's contributions are a tax deduction.

How Much?

The Internal Revenue Service (IRS) IRA rules allow individuals to contribute up to $5,000 to a tax-deferred IRA each year and deduct the contribution on their income-tax return. The contribution limit is $6,000 for people age 50 or older. If you are married filing jointly, you and your spouse each can deposit a deductible $5,000 contribution to your respective IRAs. Depending on your tax bracket, this deduction could cut hundreds of dollars off your tax bill. Earnings on your contributions accumulate on a tax-deferred basis until you withdraw them at retirement.

Deduction Reduced

Your IRA deduction is reduced or eliminated if you or your spouse is covered by a retirement plan at work. If you are single and covered by an employer retirement plan, you can still make a fully deductible $5,000 contribution to an IRA if you earned less than $56,000 for the year. The deduction is gradually phased out for income over $56,000, disappearing entirely if income exceeds $66,000. You (and your spouse) are deemed to be covered by an employer's retirement plan if you are eligible for coverage, even if you declined to participate and had no vested interest in the plan. Receiving benefits from a previous employer's retirement plan doesn't count as coverage by that plan.

Spousal Deduction

If you are married filing jointly and both of you are covered by employer retirement plans, you both can take a full IRA deduction if your combined income was less than $89,000, and a partial deduction until your combined income exceeds $109,000. If only your spouse was covered by an employer retirement plan, you each get a full IRA deduction if your combined income is below $169,000 and a partial deduction until income exceeds $179,000.

IRA Tax Credit

In addition to the tax deduction for IRA contributions, qualifying taxpayers can also claim the Retirement Savings Contribution Credit. You can get a tax credit of up to $1,000 for your IRA contributions ($2,000 if married filing jointly), which will reduce your tax bill dollar for dollar. To qualify, your income must be less than $27,750 if single and less than $55,500 if married filing jointly. You also must be over age 18, not a full-time student, and not be claimed as some else's dependent. Your credit will range from 50 percent down to 10 percent of your IRA contribution. As your income draws closer to the ceiling, the credit percentage on your contribution goes down. There's a $2,000 maximum ($4,000 if married filing jointly) on the contribution amount eligible for the credit.

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