IRA Deduction: 2 Ways You Can Miss Out
Every year, millions of investors put money into retirement accounts at the last minute with one goal in mind: getting an IRA deduction. It's true that the IRA deduction can save you hundreds or even thousands of dollars in taxes by allowing you to deduct the full amount of your IRA contribution in a given year. But there are two main situations in which you won't receive an IRA deduction for your retirement account contributions. Let's take a look at both of these and why in at least one case, it's not such a bad thing to go without an IRA deduction.
1. The IRA deduction is limited if you have a retirement plan at work and make more than certain income limits
The purpose of the IRA deduction is to encourage people to save for retirement, with a particular emphasis on those who don't have access to 401(k) plans or other employer retirement plans at work. As a result, if neither you nor your spouse can participate in an employer plan, then it doesn't matter how much money you make; you're entitled to a full deduction for your contribution.
But if you or your spouse does have coverage under a retirement plan at work, then you can end up having your IRA deduction taken away if you earn above a certain income level. If your work offers a retirement plan, then you'll get a full IRA deduction only if your modified adjusted gross income for 2014 is less than $60,000 as a single filer or $96,000 as joint filers. If your income is $60,000-$70,000 for singles or $96,000-$116,000 for joint filers, you'll be eligible for a partial deduction. At income levels above $70,000 for singles and $116,000 for joint filers, no IRA deduction is available.
Things get more complicated for married taxpayers whose spouses have retirement-plan coverage. Joint filers with modified adjusted gross income of less than $181,000 can take full IRA deductions for the spouse who isn't covered by a workplace retirement plan. From $181,000 to $191,000, a partial IRA deduction applies, and above $191,000, no deduction is available.
Nondeductible IRAs still have some benefits, including tax-deferred growth. But they are obviously less valuable than deductible IRAs, so you need to be able to guess what your income will be in order to plan appropriately.
2. Roth IRAs never give you an IRA deduction.
Many investors get confused about the distinction between a traditional IRA and a Roth IRA. Traditional IRAs are the only ones that offer the chance at an IRA deduction. Roth IRAs are never deductible, but they have benefits of their own that can sometimes outweigh the lack of an IRA deduction.
The difference between the two IRA types becomes clear in how they get treated in retirement. When you withdraw money from a traditional IRA, the amount you take out is added to your taxable income, and you'll pay taxes on it in retirement. That often works out well, as you get an IRA deduction when you're working -- and likely in a higher tax bracket -- and then pay taxes in retirement, when people are usually in a lower bracket.
With Roth IRAs, though, withdrawals in retirement are generally tax-free, meaning you don't have to include them in taxable income. For those in high tax brackets in retirement, the tax-free treatment of the Roth can more than make up for the lack of an upfront IRA deduction when they made contributions early in their careers.
Be smart about your IRA deduction
As a result, the fact that Roths don't offer an IRA deduction isn't necessarily a bad thing. The typical test is whether you're in a higher tax bracket now than you will be in retirement. If so, then using a traditional IRA to get the IRA deduction is often the better choice. If not, then forgoing an IRA deduction now in order to get the tax-free benefits of a Roth IRA in retirement is worth it.
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The article IRA Deduction: 2 Ways You Can Miss Out originally appeared on Fool.com.Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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