A traditional IRA comes with two main tax benefits for retirement savers. The first is your investments grow tax-free until it's time to make withdrawals during your retirement years. The second benefit is taken at tax time. Contributions to your traditional IRA can be partially or fully deducted from your income, thus lowering your tax obligation.
But not everyone who contributes to a traditional IRA can enjoy this upfront tax benefit. Income thresholds apply to high-income earners and employees who are covered by a retirement plan at work.
Below we discuss the contribution rules and limits in greater detail.
- Single filers and married couples filing jointly can fully deduct IRA contributions if they are not covered by an employer retirement plan.
- Income thresholds kick in if you or a spouse participate in a qualified retirement plan.
- Non-working spouses can still make an IRA contribution to their own account if the married couple files jointly and their income is greater than what both spouses contribute to their IRAs.
The most an individual can contribute to an IRA is $6,000 per year. The Internal Revenue Service (IRS) allows retirement savers who are 50 or older to make a catch-up contribution of an additional $1,000. These limits change periodically. Contributions were capped at $5,500 annually ($6,500 for those 50 and older) until 2019, when the limit was raised by $500.
Deducting Your IRA Contribution
Whether you can partially or fully deduct contributions to a traditional IRA will depend on three factors: whether you or your spouse (or both) are an active participant in an employer-sponsored retirement plan, your filing status, and your modified adjusted gross income (MAGI).
We will start by discussing employer-sponsored retirement plans. These include defined contribution plans such as the 401(k) plan, stock bonus plans, money purchase plans, and defined benefit plans such as a pension. Somewhat confusingly, IRA-based plans such as the SEP IRA and SIMPLE IRA are also employer-sponsored retirement plans. If contributions are being made to your account for any of these plans, you would be considered an active participant in an employer-sponsored retirement plan.
The easiest way to tell is to check your Form W-2. Box 13 will contain a check in the "Retirement plan" box if you are covered. If you are unsure of your status, inquire with your employer or your tax professional.
A single filer with no employer-sponsored retirement plan can deduct the full amount of a traditional IRA contribution. However, if you are covered by a retirement plan at work, then these income restrictions apply:
- A full deduction is available if your modified AGI is $65,000 or less.
- A partial deduction is available for incomes between $65,000 and $75,000.
- No deduction is available for incomes greater than $75,000.
Married Filing Jointly
Couples who are married filing jointly can take the full IRA deduction if neither spouse is covered by a retirement plan at work. If one spouse participates in a plan, then these income restrictions apply:
- A full deduction is available if your modified AGI is $196,000 or less.
- A partial deduction is available for incomes between $196,000 and $206,000.
- No deduction is available for incomes greater than $206,000.
The income thresholds are less advantageous if both spouses participate in retirement plans at work:
- A full deduction is available if your modified AGI is $104,000 or less.
- A partial deduction is available for incomes between $104,000 and $124,000.
- No deduction is available for incomes greater than $124,000.
Married Filing Separately
Taxpayers who are married filing separately are subject to drastically lower income thresholds if either spouse participated in an employer-sponsored retirement plan. If your income is less than $10,000, you can take a partial deduction. Once your income hits $10,000, you are not entitled to any deduction. There are no income limits if neither spouse has a work sponsored plan.
Roth IRA Contributions
If you do not qualify for a traditional IRA, consider contributing to a Roth IRA. Contributions are made with after-tax dollars, qualified withdrawals are tax free when you retire, and there are no required minimum distributions (RMDs), meaning you can let your investments grow as long as you like.
Roth IRA contribution rules are a tad easier to navigate. Single filers earning $124,000 or less can contribute the maximum amount. Married couples who file jointly can contribute the max if they earn $196,000 or less. It is married couples filing separately (but still living together) who will find the fewest advantages. They can only contribute a reduced amount, and only on incomes of $10,000 or less. Otherwise, if they lived apart for the full tax year, they can earn up to $124,000 and still contribute the maximum to a Roth IRA.
Spousal IRA Contribution
A spousal IRA allows both spouses to maximize their traditional IRA contributions, even if one spouse is not working or has very little qualified income. In order to make a spousal IRA contribution, both IRAs must be maintained as separate accounts (they cannot be held jointly). In addition, the couple must file a joint tax return. Your combined contribution will be the lesser of $12,000 (or $14,000 if both spouses are 50 or older), or your total taxable compensation for the year.
The deadline for making an IRA contribution is the due date for filing your tax return for the year you are making the contribution. Generally, this means you have a full year, plus until April 15 the following year, to deposit the funds into your IRA account. If April 15 falls on a weekend or holiday, the deadline is the next business day.
In response to the coronavirus pandemic, the IRS extended the 2019 income tax filing deadline until July 15, 2020, giving tax payers an additional three months to make an IRA contribution.
When making a contribution for the preceding year, be sure to indicate the applicable year on your check or any accompanying contribution form. If you do not provide this information, your IRA custodian or trustee will not be able to determine the year for which you want the contribution to be made. As a result, the contribution will likely get reported for the tax year in which they received the check.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act eliminated the age restriction on traditional IRA contributions, beginning in 2020. In other words, as long as you have income from work, you can contribute to your IRA. For 2019 and earlier, those 70½ or older were barred from making traditional IRA contributions.
The Bottom Line
Many factors determine whether a taxpayer can deduct a contribution to a traditional IRA from their income taxes. If you have a high income, or you participate in an employer-sponsored retirement plan, it's worthwhile checking with a financial planner or retirement consultant to see if you qualify for this tax benefit.