IRA Contributions: Deductions and Tax Credits

How to take full advantage of the benefits

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.

Key Takeaways

  • The benefits of contributing to an IRA include tax deductions, tax-deferred or tax-free growth on earnings, and tax credits if you're eligible.
  • The deductibility of your contributions is determined by your income and your tax-filing status.
  • You can make nondeductible IRA contributions even if your traditional IRA contribution isn't deductible.
  • 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 or Roth IRA or an employer-sponsored retirement plan.

Receiving a Tax Deduction

If you do not participate in an employer-sponsored plan, such as a 401(k), a SEP IRA, a SIMPLE IRA, or another qualified plan, contributions to your traditional IRA may be tax-deductible.

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 and your spouse file separately, you're married and file jointly, or you're a single filer.

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 2022 and 2023 tax years, which are as follows:

MAGI and Contribution Limits for Roth IRAs for 2022 and 2023
Filing Status 2022 MAGI Limit 2023 MAGI Limit Roth IRA Contribution Limit
Married Filing Jointly Less than $204,000 Less than $218,000 Full contribution
  $204,000 to $214,000 $218,000 to $228,000 Partial contribution
  $214,000 or more $228,000 or more No contribution allowed
Married Filing Separately $0 to $9,999 $0 to $9,999 Partial contribution
  $10,000 or more $10,000 or more No contribution allowed
Single Less than $129,000 Less than $138,000 Full contribution
  $129,000 to $144,000 $138,000 to $153,000 Partial contribution
  $144,000 or more $153,000 or more No contribution allowed

For the table above, the full contribution limit is $6,000 for 2022 and $6,500 for 2023. In addition, individuals 50 years old and older qualify for an additional $1,000 catch-up contribution. 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. Again, the limit for 2022 is $6,000 and the limit for 2023 is $6,500. For those who are 50 or older, an additional catch-up contribution of $1,000 is allowed.

Saver’s Credit

Make sure to find out if you are eligible for the IRS’s saver’s credit. You qualify if you meet the following criteria:

  • You're over 18
  • You aren't claimed as a dependent on someone else's tax return
  • You aren't a student

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 and 2022 tax credits that are allowed for combinations of particular income ranges and tax-filing statuses:

2022 Saver's Credit
Credit Rate Married and files a joint return Files as head of household Other category of filers
50% AGI up to $41,000 AGI up to $30,750 AGI up to $20,500
20% $41,001- $44,000 $30,751 - $33,000 $20,501 - $22,000
10% $44,001 - $68,000 $33,001 - $51,000 $22,001 - $34,000
0% More than $68,000 More than $51,000 More than $34,000
2023 Saver's Credit
Credit Rate Married and files a joint return Files as head of household Other category of filers
50% AGI up to $43,500 AGI up to $32,625 AGI up to $21,750
20% $43,501- $47,500 $32,626 - $35,625 $21,751 - $23,750
10% $47,501 - $73,000 $35,626 - $54,750 $23,751 - $36,500
0% More than $73,000 More than $54,750 More than $36,750

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.

What Is the Difference Between an IRA and a 401(k)?

An IRA is a self-managed retirement amount where you select your own broker, have a broader range of retirement investment options, and can have automatic withdrawals taken out of your bank account. A 401(k) is managed by your employer, though you do get to select your contribution amount and investments. Each type of retirement account has different contribution limits, income thresholds to contribute, and rules around distributions.

What Is the Difference Between a Roth IRA and a Traditional IRA?

A Roth IRA allows an individual to contribute to a retirement account. However, these contributions are not tax deductible when contributions are made. In exchange, investment scan grow tax-free and not subject to tax liability when withdrawn at retirement.

A traditional IRA acts in a similar way. However, traditional IRA contributions are tax deductible when made. The downside to this is that investments are taxable upon withdrawal.

What Are the Downsides of an IRA?

Traditional IRA contributions can't be withdrawn until retirement. This locks your funds into an account that you may not be able to touch for decades without paying taxes and penalties. Roth IRA funds may be withdrawn as long as they do not exceed contributions.

IRAs also incur many downsides like other financial products. IRAs do not guarantee returns, and you may lose capital that you invest. These accounts or trading activity may incur fees, and you will be subject to minimum distribution requirements when you reach age 72.

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.

Article Sources
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