Deductions vary depending on your modified adjusted gross income (MAGI) and whether or not you're covered by a retirement plan at work. If you (and your spouse, if applicable) aren't covered by your employer's retirement plan, your traditional IRA contributions are fully tax-deductible. Whether your IRA contributions are tax-deductible depends on the type of IRA you plan to open. Contributions to Roth IRAs can never be deducted from income tax returns, since the account allows withdrawals from distributions and profits to be tax-free.
Taxes must be paid on all contributions to your Roth IRA in the year in which the income is earned. Understanding the IRA deduction rules is key to making the right investment decisions based on your circumstances. If you need to prioritize, it often makes sense to contribute enough to your 401 (k) account to get the maximum matching contribution from your employer. However, for those with higher incomes, deductions for IRA contributions are limited if they (or their spouse, if married) have a retirement plan at work.
The IRA is one of several retirement savings plans that are qualified by the Internal Revenue Service (IRS), meaning that they offer special tax benefits to people who invest in them. A traditional IRA is an individual retirement account that you can contribute money to before or after taxes, giving you immediate tax benefits if your contributions are tax-deductible. Whether you receive a tax deduction for a contribution to an IRA depends on a variety of factors, such as the type of account, whether you're covered by an employer-sponsored retirement plan, and your income. A self-directed IRA gives you the ability to diversify your portfolio with additional investments allowed by the IRS, in a tax-free or tax-deferred environment.
Your ability to deduct an IRA contribution in part or in full depends on how much you earn, whether you or your spouse are currently contributing to other qualified retirement plans, and what type of IRA you have. As an employer, you can deduct contributions made to employees' SIMPLE IRAs on your business tax return. If you are self-employed or own a business with up to 25 employees, you may be eligible to establish a SEP IRA. Contributions to a traditional IRA, which is the most common option, are deductible in the tax year in which they are paid.
The requirements for an IRA deduction are based on your income, which must be below certain thresholds depending on your reporting status. See publication 590-A, Contributions to Individual Retirement Arrangements (IRA), for additional information, including how to declare your IRA contributions on your individual federal income tax return. If you are self-employed and contribute to your own SEP-IRA, there is a specific calculation to determine the maximum deduction. There's no income limit for a traditional IRA, and depending on how much you earn and if you're enrolled in your employer's retirement plan, your contributions may be tax-deductible.
However, after that, adding an IRA to your retirement plan may provide you with more investment options and possibly lower fees than what you charge with your 401 (k) plan.