Tax Deductions and Credits on IRA Contributions

The important benefits of contributing towards an IRA are the tax deductions against annual income, tax-free growth of earnings and the non-refundable tax credits. You want to maximize the returns you get from contributing to your IRA, therefore it is essential to know the rules & limits placed behind these priviledges we just mentioned.

i) IRA Tax Deductions

In a traditional IRA, any contributions you make are tax-deductible and any withdrawals you make will be taxed by the federal government upon withdrawal. However, if you contribute to an SEP IRA, Simple IRA or a Qualified IRA plan, you are considered an ‘active participant’ and the deductibility of your contributions is determined by your modified adjusted gross income (MAGI). The deductibility of your contributions is also determined by your tax-filing status; whether you are ‘married filing separately’, ‘married filing jointly’ or ‘single.’

If your Traditional IRA contributions are not tax-deductible, you can still contribute towards a traditional IRA. Alternatively, you can contribute towards a Roth IRA, here are the modified adjusted gross income (MAGI) limits.

Tax Filing Status Modified Adjusted Gross Income (MAGI) Roth IRA Contribution Limits
Single $101,000 or less $5000 + Catch Up Contribution ($1000)
Between $101,000 and $116,000 Partial Contribution
More than $116,000 No Roth IRA Contribution allowed
Married filing joint $159,000 or less $5000 + Catch Up Contribution ($1000)
Between $159,000 and $169,000 Partial Contribution
More than $169,000 No Roth IRA Contribution allowed
Married filing Separately Between $1 and $10,000 Partial Contribution
More than $10,000 No Roth IRA Contribution allowed

Note: If your income falls in between the ranges that allow only ‘partial contributions’, you can use a special formula to determine that partial contribution.

Tip: If you are married but have lived away from your spouse for the entire tax year, you are not considered as ‘married’ for tax filing purposes. Your Roth IRA MAGI limits will be based on single limitations.

Note: If you make a non-deductible contribution to your traditional IRA, make sure you fill out IRS Form 8606. This form will help you and the IRS keep track of non-taxable balances in your Traditional IRA, should you make any withdrawals upon retirement. Download IRS form 8606 @ www.irs.gov

Split Your Contributions

Splitting your contributions between a traditional IRA and a Roth IRA can be beneficial in some cases. These cases are if:

i) You are eligible only for partial contributions to a traditional IRA. Instead of contributing the non-tax deductible amount to the traditional IRA (and grow it tax-deferred), contribute it to a Roth IRA where it grows tax-free.

ii) You are eligible only for partial contribution to a Roth IRA. To maximize your contributions for the year, contribute the remaining difference to a traditional IRA.

Note: Your combined contributions to a Roth IRA and a traditional IRA should NOT exceed stated IRA contribution limits of $5000 for the year 2010.

IRA Tax Credits

You might be eligible for a non-refundable tax credit of up to 50% of your IRA contributions depending on your adjusted gross income and tax-filing status. Here is the table specifying tax credits under each tax-filing status.

Married & Filing Joint File as Head of Household Other Tax-Filing Status Tax Credit Percentage
Up to $32,000 Up to $24,000 Up to $16,000 50%
$32,001 – $34,500 $24,001 – $25,875 $16,001 – $17,250 20%
$34,501 – $53000 $25,876 – $39,750 $17,251 – $26,500 10%

These non-refundable tax credits are allowed in addition to any deductions you get for your IRA contributions. To claim the non-refundable tax credits, be sure to file IRS Form 8880.

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