If you qualify, making a contribution to a Traditional IRA can help you lower your taxes. You could save anywhere from $500 to $3,000 on your federal income taxes! You could also save on your state or local income taxes depending on how they’re calculated. Here’s what you need to know:
What is a Traditional IRA?
A Traditional IRA is a tax-deferred account designed to help you save for retirement while providing tax benefits. If you qualify, contributions to a Traditional IRA are tax-deductible up to certain limits. Interest, dividends, and capital gains are not taxable inside a Traditional IRA. You’ll have to pay ordinary income taxes on withdrawals from a Traditional IRA.
Do You Qualify?
To be eligible to take a tax deduction for your Traditional IRA contributions, you must meet these requirements:
- You must have earned income equal to or exceeding your Traditional IRA contributions.
- You must be under age 70 1/2.
- If you (or your spouse) are covered by an employer-sponsored retirement plan, your income must be under a certain limit depending on your situation (single or married).
Earned income includes anything you receive a W-2 for or any profits from self-employment. Things like interest and dividends are considered unearned income because you didn’t actually do any work to receive them. For IRA purposes, earned income can also include alimony or separate maintenance payments.
How Much Can You Contribute?
How much you can contribute depends on your adjusted gross income (AGI) and whether you or your spouse are covered by an employer-sponsored retirement plan. You can find out for sure by looking on your W-2. If there’s an “X” in box 13, then you’re covered. Your AGI is all of your income minus any deductions you can take on the first page of Form 1040 down to the IRA deduction. Those deductions are quite limited, so it will probably just be your total income (including interest, dividends, capital gains, etc.).
If you’re single and you’re not covered by an employer-sponsored retirement plan, the maximum you can contribute (and deduct) to a Traditional IRA for 2009 is $5,000 ($6,000 if you’re 50 or older). If you’re married and neither you nor your spouse are covered by an employer-sponsored retirement plan, you can each contribute (and deduct) $5,000 (make it $6,000 if you are 50 or older). If only one of you is 50 or older, then that person can contribute $6,000 but the other can only contribute $5,000. There are no income limitations when neither you nor your spouse are covered by an employer-sponsored retirement plan.
If you’re single and you are covered by an employer-sponsored retirement plan, your 2009 AGI must be below $55,000 to be able to contribute the maximum of $5,000 (or $6,000 if you’re 50 or older). The amount you can contribute gets phased out proportionally if your AGI is between $55,000 and $65,000. For example, if your AGI is $60,000, you can only contribute $2,500 (or $3,000 if you’re 50 or older) to a traditional IRA. You can’t contribute (and deduct) anything if your AGI is above $65,000.
If you’re married, it gets a little more complicated. If both you and your spouse are covered by an employer-sponsored retirement plan, your 2009 AGI must be below $89,000 to get the maximum contribution for both of you. The phaseout begins at $89,000 and goes up to $109,000. Neither you nor your spouse can contribute (and deduct) anything if your AGI is above $109,000. If one of you is covered by an employer-sponsored retirement plan and the other is not, there are two separate limits. To be able to deduct a Traditional IRA contribution for the spouse who is covered, your AGI must be below $89,000 (just as above) with a phaseout going up to $109,000. But to deduct a Traditional IRA contribution for the spouse who is not covered, your AGI only needs to be under $166,000 with a phaseout going up to $176,000. It’s possible that you can only make a deductible Traditional IRA contribution for one of you and not the other (if your AGI is between $109,000 and $176,000).
When to Contribute
You can make contributions to your Traditional IRA until April 15 of the following tax year (just like Roth IRAs and HSAs). So if you want to make a contribution for 2009, you have until April 15, 2010 to do so.
Don’t Forget to Claim the Deduction!
You’ll need to make sure you claim your deduction for Traditional IRA contributions on your federal income tax return. You’ll take the deduction on line 32 of Form 1040. (Or you can just tell your tax preparer.) If you don’t claim the deduction, you won’t get any benefit at all!
More Free Tax Saving Tips!
If you want to learn more ways to (legally) reduce your taxes, sign up for free updates to Provident Planning. It’ll only cost you a minute of your time, but you might just learn how to save yourself hundreds or thousands of dollars!
If you enjoyed this, you might like:
- Would Jesus Support the Buffet Tax Law?
- Tax Tip: Combine a Traditional IRA Deduction with the Retirement Savings Contribution Credit
- Is Renting Throwing Away Money?
- The Hobby Loss Rule: What It Is and Why You Don't Want to Break It
- Free Spreadsheet to Track Business Expenses for Schedule C