It’s a Win-Win: You May Save on Taxes While You Save for Retirement

How’s this for a sweet deal: With one move, you may reduce your federal income tax bill and take an important step toward financial security in retirement.

Those are two potential benefits of making a contribution to a Traditional Individual Retirement Account (IRA). Your contribution can help you accumulate money for later in life and you may be eligible to deduct that contribution on your tax return.  Here is some basic information on how the tax benefit works and who qualifies for tax year 2018.

The mechanics of a tax deduction

A tax deduction can reduce the amount of taxable income that is used to figure your tax bill. As an example, let’s say you have an effective federal tax rate of 25% and contribute $5,500 of your pay to a Traditional IRA. That’s the maximum annual contribution for people younger than 50 in 2018. If you are eligible to deduct your contribution, you don’t owe tax on that $5,500 in income now. That reduction in taxable income can reduce your federal tax bill by $1,375 (that’s 25% of the $5,500).

You can make a Traditional IRA contribution for 2018 as late as the tax filing deadline of April 15, 2019, and potentially get a tax benefit on your tax return for 2018.  

Do you qualify for a Traditional IRA deduction?

Your eligibility to deduct contributions to a Traditional IRA depends on a number of factors, including your marital status, your modified adjusted gross income (AGI), and whether you’re covered by an employer-sponsored retirement plan, like a 401(k).  You can read the details in IRS Publication 590-A.

Here are some key points:

  • If you are single and you aren’t covered by a workplace retirement plan, you can take a full deduction up to your contribution limit.
  • If you are married filing a joint tax return and neither you nor your spouse has a retirement plan at work, you can also take a full deduction up to your contribution limit.
  • If you are covered by a retirement plan at work, whatever your marital status, your deduction may be reduced or completely disallowed based on your modified AGI. For tax year 2018, the reductions kick in when modified AGI exceeds $63,000 for a single filer or $101,000 for a married couple filing jointly. For other tax situations and additional details, here is an IRS table with the rules for 2018. One note: If you are married filing separately and lived with your spouse during the year, you aren’t eligible for a deduction if your modified AGI is $10,000 or more.
  • If you are not covered by a workplace retirement plan but you are filing jointly with a spouse who is covered by a workplace plan, your deduction may be reduced or completely disallowed based on your modified AGI.  For 2018, the reduction kicks in when modified AGI exceeds $189,000. For other tax situations and additional details, here is an IRS table with the rules for 2018. If you are married filing separately and lived with your spouse during the year, you aren’t eligible for a deduction if your modified AGI is $10,000 or more.

Other IRA options

A Traditional IRA is one of two basic varieties of these tax-advantaged retirement accounts. If you qualify for deductible contributions to a Traditional IRA, your withdrawals in retirement will be taxable income. The other basic variety, a Roth IRA, provides tax-free withdrawals in retirement but doesn’t offer an upfront deduction. 

Here are tips on comparing a deductible Traditional IRA and a Roth if you qualify for both. If you aren’t eligible to deduct a Traditional IRA contribution, you may still qualify to contribute to a Roth IRA.

If you have self-employment income, including from a sideline business, you may also be eligible for a SEP IRA, with tax treatment similar to that of a Traditional IRA.

 

At Honest Dollar by Goldman SachsTM, individuals can open a Traditional, Roth or SEP IRA in minutes and get access to diversified investment portfolios designed by Goldman Sachs Asset Management.


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