Do you have an Independent Retirement Account (IRA)? Great! You are on your way to planning for your “3rd Act” of retirement. 

Can you claim a tax deduction on contributions you make to your retirement account?

Well, that depends….

The answer to this question is not a simple “Yes” or “No” because it is contingent on a number of different factors. Financial and tax professional sometimes refer to this as an “eligibility maze”. Here’s a sample of what the “eligibility maze” looks like for IRA related tax deductions:

  • Do you have wages? The income you contribute must be derived from wages, not from passive income such as investment or rental income.
  • Do you participate in an employer retirement plan? If you do, you might not qualify for a deduction unless your income is below a certain threshold.
  • What is your income level? If you exceed certain specified income levels, your contribution may not be tax-deductible. But you can still contribute and your funds can grow on a tax-advantaged basis.
  • Are you single or married? If you are single, the rules are easy to understand. If you are married, and one spouse is covered in an employer-sponsored plan and the other isn’t, then the rules get a little murky.

Here is the simplest rule. If you do not participate in an employer-sponsored retirement plan, then there’s good news for you. Your contributions to a traditional IRA are tax-deductible, although the maximum you can contribute to your traditional IRA is capped. If you are age 50 or over, you can make an additional “catch-up contribution” each year. The amount of the contribution and the catch-up contribution often change—so be sure to consult your financial planner or retirement account administrator to make sure you are putting aside as much as you are allowed to.

What about those who are participating in an employer-sponsored retirement plan? The good news for you is that your contributions to your IRA might still be fully or partially deductible, depending on your income. Earners above a certain threshold are not allowed to claim a tax deduction. The exact amount of this threshold can change year-to-year. So always check with your financial planner or tax preparer to find out if you qualify. This is also one of those areas where singles and married couples filing jointly usually have a major advantage over married couples filing separately. The income threshold for people who are “married filing separately” is much lower than for either singles or married filing jointly. Married couples who do file separately can calculate their eligibility the “single” status, but only if they lived separately for the entire year.

Let’s say you don’t meet any of these criteria. Now what do you do? Don’t despair. You can still fund a traditional IRA and enjoy tax-deferred earnings. The one caveat is that you lose the up-front tax deductibility of your contribution.

And, hey, if you’re looking at funding an IRA with after-tax money anyway, why not fund a Roth IRA instead? Contributions to a Roth IRA are always made with after-tax dollars, but distributions from a Roth IRA are tax-free—compared to traditional IRAs where the distributions are taxable. As with traditional IRAs, though, certain income thresholds come into play when contributing to a Roth IRA. But there are work-arounds if your income exceeds these levels, which we’ll cover in another post!

For more information, please visit the IRS website.


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