The primary benefits of contributing to an individual retirement account (IRA) are the tax deductions, the tax-deferred or tax-free growth on earnings, and if you are eligible, nonrefundable tax credits. To get the most out of contributing to your IRA, it’s important to understand what these benefits mean and the limitations placed on them.
- The benefits of contributing to an IRA include tax deductions, tax-deferred or tax-free growth on earnings, and if you are eligible, tax credits.
- The deductibility of your contributions is determined by your income and your tax-filing status.
- Splitting your contribution between a traditional and Roth IRA can be a good move in certain circumstances.
- A nonrefundable tax credit is available to eligible taxpayers who contribute to a traditional and/or Roth IRA or an employer-sponsored retirement plan.
Receiving a Tax Deduction
However, if you participate in any of these plans, you may be considered an active participant, and the deductibility of your contributions would be determined by your modified adjusted gross income (MAGI) and your tax-filing status—that is, whether you file “married filing separately,” “married filing jointly,” or “single.
If your traditional IRA contribution is not deductible, you may still make a nondeductible IRA contribution to it. Alternatively, you may contribute to a Roth IRA, provided your MAGI satisfies the Roth IRA eligibility limits for the 2021 tax year, which are as follows:
|MAGI and Contribution Limits for Roth IRAs for 2021|
|Filing Status||MAGI Limit||Roth IRA Contribution Limit|
|Married Filing Jointly||Less than $198,000||$6,000 per person plus $1,000 catch-up contribution per person for people age 50 and up|
|$198,000 to $207,999||Partial contribution|
|$208,000 or more||No contribution allowed|
|Married Filing Separately||$0||$6,000 plus $1,000 catch-up contribution for people age 50 and up|
|$1 to $9,999||Partial contribution|
|$10,000 or more||No contribution allowed|
|Single||Less than $125,000||$6,000 plus $1,000 catch-up contribution for people age 50 and up|
|$125,000 to $139,999||Partial contribution|
|$140,000 or more||No contribution allowed|
If your income falls between the ranges that allow only a partial contribution, you may use a special formula to determine that partial contribution. This IRA calculator will further help you determine if you’re eligible for an IRA.
Should you decide to make a nondeductible contribution to your traditional IRA, be sure to file IRS Form 8606, which helps you and the IRS keep track of the nontaxable balance in your traditional IRAs, ensuring that you do not pay taxes on distributions that should be tax-free.
If you are married but lived apart from your spouse for the entire year, you must file in the “single” category.
Splitting Your Contribution
Splitting your contribution between your traditional and Roth IRA may be beneficial in certain circumstances:
- If you are eligible for only a partial deduction on your traditional IRA. Instead of contributing the nondeductible amount to a traditional IRA, in which earnings grow tax-deferred, you can contribute the amount to a Roth IRA, in which earnings grow tax-free.
- If you are eligible for only a partial Roth IRA contribution. To maximize your contribution for the year, you can contribute the difference to your traditional IRA.
Your combined contributions to your Roth and traditional IRAs should not exceed the IRA contribution limit, which for tax years 2020 and 2021 is $6,000 for people who are under 50. For those who are 50 or older, an additional catch-up contribution of $1,000 is allowed.
Make sure to find out if you are eligible for the IRS’s saver’s credit. You may be eligible for a nonrefundable tax credit of up to 50% of your IRA contribution, not exceeding $1,000, depending on your adjusted gross income (AGI) and tax-filing status. Below are the 2021 tax credits that are allowed for combinations of particular income ranges and tax-filing statuses:
|2021 Saver's Credit|
|Credit Rate||Married and files a joint return||Files as head of household||Other category of filers|
|50%||AGI up to $39,500||AGI up to $29,625||AGI up to $19,750|
|20%||$39,501 - $43,000||$29,626 - $32,250||$19,751 - $21,500|
|10%||$43,001 - $66,000||$32,251 - $49,500||$21,501 - $33,000|
|0%||More than $66,000||More than $49,500||More than $33,000|
This non-refundable tax credit is allowed in addition to any deduction you may receive for your IRA contribution.
In order to claim the nonrefundable tax credit, you must file IRS Form 8880, the most current version of which is available on the IRS website.
The Bottom Line
As the earnings in your traditional IRA grow on a tax-deferred basis—and on a tax-free basis in your Roth IRA—you have plenty of reasons to contribute to an IRA, along with the benefits discussed above. However, you may want to consult with a financial advisor to determine whether your savings should be directed to other vehicles.
For instance, if you receive a matching contribution in a 401(k) plan, it generally makes better financial sense to contribute the amount necessary to receive the maximum match—and then only contribute to an IRA if you can still afford to do so.
Internal Revenue Service. "IRA Deduction Limits." Accessed Mar. 3, 2021.
Internal Revenue Service. "Amount of Roth IRA Contributions That You Can Make for 2021." Accessed Mar. 3, 2021.
Internal Revenue Service. "About Form 8606, Nondeductible IRAs." Accessed Mar. 3, 2021.
Internal Revenue Service. "Retirement Topics - IRA Contribution Limits." Accessed Mar. 3, 2021.
Internal Revenue Service. "Retirement Savings Contributions Credit (Saver’s Credit)." Accessed Mar. 3, 2021.