The primary benefits of contributing to an IRA are the tax deductions, the tax-deferred or tax-free growth on earnings and, if you are eligible, the non-refundable 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.
Receiving a Tax Deduction
If you do not participate in an employer-sponsored plan, such as an SEP IRA, SIMPLE IRA or qualified plan, contributions to your Traditional IRA may be tax deductible. However, if you participate in either 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 file “married filing separately,” “married filing jointly” or “single.”
If your Traditional IRA contribution is not deductible, you may still make a non-deductible IRA contribution to it. Alternatively, you may contribute to a Roth IRA, provided your MAGI satisfies the Roth-IRA eligibility limits for 2018, which are as follows:
|Tax-Filing Status||MAGI||Roth IRA Contribution Limits|
|Single||$120,000 or less||Up to $5,500 plus a catch-up|
|Between $120,000 and $134,999||Partial contribution|
|More than $135,000||No Roth-IRA contribution allowed|
|Married filing jointly||$189,000 or less||Up to $5,500 plus a catch-up|
|Between $189,000 and $198,000||Partial contribution|
|More than $199,000||No Roth-IRA contribution allowed|
|Married filing separately||Up to $10,000||Partial contribution|
|More than $10,000||No Roth-IRA contribution allowed|
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.
Tip: If you are married but you lived apart from your spouse for the entire year, you are not treated as married for tax-filing purposes. Therefore, you would fall into the “single” category.
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 keeps track of the non-taxable balance in your Traditional IRAs, ensuring that you do not pay taxes on distributions that should be tax-free.
Splitting Your Contribution
Splitting your contribution between your Traditional and Roth IRA may be beneficial in certain circumstances:
- You are eligible for only a partial deduction on your Traditional IRA. Instead of contributing the nondeductible amount to a Traditional IRA, where earnings grow tax-deferred, you can contribute the amount to a Roth IRA where earnings grow tax-free.
- 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.
Tip: Your combined contribution to your Roth and Traditional IRA should not exceed the IRA contribution limit, which for 2018 is $5,500 for people who are under 50; for those who are 50 or older, a catch-up contribution of $1,000 is allowed.
You may be eligible for a non-refundable tax credit of up to 50% of your IRA contribution, not exceeding $1,000, depending on your adjusted gross income and tax-filing status. Here are the tax credits that are allowed for combinations of particular income ranges and tax-filing statuses:
|Credit Rate||Married and files a joint return||Files as head of household||Other category of filers|
|50%||Up to $38,000||Up to $28,500||Up to $19,000|
|20%||$38,001– $41,000||$28,501– $30,750||$19,001– $20,500|
|10%||$41,001 – $63,000||$30,751– $47,250||$20,501 – $31,500|
This non-refundable tax credit is allowed in addition to any deduction you may receive for your IRA contribution.
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 along with the benefits discussed above, plenty of reasons to contribute to an IRA. However, you may want to consult with your financial advisor to determine if your savings should be directed to other vehicles. For instance, if you receive a matching contribution in a 401(k) plan, it may make better financial sense to contribute the amount necessary to receive the maximum match, and then, only if you can still afford to make contributions to your IRA. In addition, consult with your tax professional for assistance in determining your eligibility and deductibility.