It depends, first of all, on the type of IRA you have.

If you are contributing to a traditional IRA, the answer is yes. The money that is deposited into a traditional IRA reduces your adjusted gross income (AGI) for that tax year dollar-for-dollar, assuming it is within the contribution limits (see below). So a qualifying contribution of, say, $2,000 could reduce your AGI by $2,000, giving you, the account holder, a tax break for that year. This is what is known as making a contribution with pre-tax dollars.

On the other hand, a contribution to a Roth IRA does not reduce your AGI in the tax year you make it. Roth contributions are funded with after-tax dollars, meaning there's no tax break at the time of your deposit. However, when the money is withdrawn from the account (presumably after you retire), no income tax is due on it. In contrast, you do pay taxes on distributions from your traditional IRA in the year you take them.

Of course, with both types of IRAs, your funds grow tax-free while in the account.

Key Takeaways

  • Contributions to a traditional IRA can reduce your adjusted gross income for that year by a dollar-for-dollar amount.
  • If you have a traditional IRA, your income and whether or not you have a workplace retirement plan may limit the amount by which your AGI can be reduced.
  • Contributions to a Roth IRA do not lower your adjusted gross income.

IRA Contribution Limits

The IRS places limits on the amount you can invest annually in an IRA, whether Roth or traditional. For the 2019 tax year, the IRA limit for contributors is $6,000 (the first increase since 2013) plus a $1,000 catch-up contribution for taxpayers who are age 50 and over. The contribution maximums apply collectively to all your IRAs; they are not per account.

The IRS allows deductions on contributions to a traditional IRA, but the deduction may be reduced or phased out if you (or your spouse, if you are married) are covered by a retirement plan at work. For the 2019 tax year, a single filer covered by a workplace plan can take a full deduction if their AGI is under $64,000 or a partial one if they make between $64,000 and $74,000; above that amount, the deduction is eliminated. For married couples filing jointly where the IRA-contributing spouse is covered by a workplace retirement plan, they can take a full deduction if their AGI is below $103,000 annually, a partial one if it's between $103,000 and $123,000, and none if their AGI above that amount. If the other spouse has the workplace plan, the phase-out applies to a joint income between $193,000 and $203,000.

For Roth IRAs, your income determines whether or not you can contribute (contributions are never tax deductible). Single taxpayers face a phase-out range of $122,000 to $137,000; joint filers, $193,000 to $203,000.

The IRS imposes penalties if you contribute more than the allowable amount to an IRA.

Withdrawing IRA Funds

Traditional IRA account-holders are not permitted to withdraw funds for retirement until they turn 59½. After that, they can begin to remove funds without restrictions. After age 70½, the IRA holder is required to take a required minimum distribution (RMD) each year, based on the balance of the IRA and the life expectancy tables published by the IRS. If the IRA holder elects not to take their RMD, they are charged a penalty of 50% of the RMD amount.

Holders of Roth IRAs can withdraw an amount equivalent to their contributions at any time. However, withdrawn earnings before age 59½ are subject to a penalty of 10% plus an income tax payment, with some provisions. Account-holders may begin to withdraw the earnings or gains on their funds after age 59½ without penalty or taxes, provided that the account has been open for five or more years. If the account is less than five years old, a 59½-year-old account holder will be required to pay taxes on the withdrawal, but won't be subject to penalties.

Advisor Insight

Michael Shea, CFP®
Applied Capital, Nashville, TN

You can elect to make deductible or non-deductible contributions to a traditional IRA. Should you choose to make deductible contributions, you can contribute up to $6,000—or $7,000 if you are age 50 or older—which will reduce your AGI by the respective amount. The deductibility is based on whether you or your spouse are covered by a retirement plan at work. If you are married and covered by an employer retirement plan then the modified adjusted gross income phase-out begins at $103,000 and ends at $123,000, where you will receive no deduction. If you are single the phase-out is less.