Is it possible to deduct contributions to an individual retirement account (IRA)? The quick response for many of us is: You bet! That is the purpose of IRAs. There are, however, regulations and limitations.
Your eligibility to deduct an IRA contribution in part or in whole is determined by your income, whether you or your spouse presently contribute to other qualifying retirement plans, and the kind of IRA you have. Keep in mind that restrictions are modified for inflation each year.
- Traditional IRA contributions are tax deductible in the year they are made.
- The amount you may deduct for an IRA contribution is determined on your income, whether you or your spouse already contribute to another plan(s), and the kind of IRA you have.
- Contributions to a Roth IRA are taxed when they are made, not when the money is taken in retirement.
- Deductibility has higher income restrictions that vary depending on your tax filing status.
- Limits are modified for inflation each year.
Understanding Retirement Accounts and Tax Deductions
The IRA is one of a variety of retirement savings plans that are IRS-qualified, which means they provide particular tax advantages to those who invest in them. They are the primary vehicle for tax-deferred retirement savings for self-employed individuals.
If you have a regular IRA rather than a Roth IRA, you may deduct up to $6,000 in contributions for 2021 and 2022. If you are 50 or older, you may add $1,000 to that. From there, you must understand the rules and limitations.
If You Have Other Retirement Accounts
In 2021 and 2022, you may deduct a total of $6,000 or $7,000 for all contributions to eligible retirement plans. Having a 401(k) plan at work does not exclude you from making IRA contributions, and you may deduct up to the maximum yearly contribution of $19,500 in 2021 and $20,500 in 2022.
If you must prioritize, it is frequently best to contribute enough to your 401(k) account to get the full match from your company. However, using an IRA in your retirement portfolio might give you with additional investment alternatives and probably cheaper costs than your 401(k).
Which Type of IRA Do You Have?
Contributions to the most prevalent kind of IRA, the regular IRA, are deductible in the tax year in which they are made. You won’t have to pay taxes on your contributions or the investment returns until you retire.
According to the IRS, your contribution to a conventional IRA decreases your taxable income and, as a result, the amount you owe in taxes.
A Roth IRA contribution is not tax deductible. The money you deposit into the account is subject to full income taxation. When you retire and begin taking funds, you will owe no taxes on your contributions or investment returns.
If your employer does not provide a retirement plan, you may deduct your contribution regardless of your income. Deductions for IRA contributions are restricted for persons with higher salaries if they (or their spouse, if married) have a workplace retirement plan. These limitations are determined by your filing status.
If You Are a Single Filer
The maximum tax-deductible contribution for individuals with a workplace retirement plan begins to decline after their modified adjusted gross income (MAGI) exceeds $66,000 in 2021 and $68,000 in 2022.
If your adjusted income exceeds $76,000 or $78,000 in 2021 or 2022, the tax deduction will be phased away.
If You Are Married Filing Jointly
This is when things become tricky. The maximum tax-deductible contribution for married couples filing jointly varies dramatically if one person contributes to a 401(k), and it may be capped for higher-income couples.
- If the spouse making the IRA contribution is enrolled in an employment retirement plan, the deduction starts to phase down at $105,000 in AGI and ends at $125,000 in 2021 (and $109,000 and $129,000 in 2022).
- If the IRA donor does not have a workplace plan but their spouse does, the 2021 maximum is $198,000, and no tax deduction is available if the contributor’s income exceeds $208,000 ($204,000 and $214,000 for 2022).
If You Are Married Filing Separately
The tax deduction limitations for married taxpayers filing separately are much smaller, regardless of whether they or their spouses participate in an employer-sponsored retirement plan. You may claim a partial deduction if your income is less than $10,000. Once your income exceeds $10,000, you are no longer eligible for a deduction.
The Bottom Line
If your income is less than the year’s limit and you don’t have any other retirement accounts, you may make the maximum contribution and it will be completely deductible.
Don’t give up on saving for retirement if you don’t qualify for the tax break. This is why: Even if you cannot deduct some or all of your contributions to a conventional IRA, your investment will grow tax-free until retirement. Remember that you may make a donation up to the next year’s tax-filing deadline, which is normally April 15th.
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