Can I Contribute to an IRA & Reduce My Federal Taxes?

Contributing to an IRA may reduce your federal taxes.

Contributing to an IRA may reduce your federal taxes.

Individual retirement accounts allow you to set aside money for your sixth decade while offering you tax advantages. With a traditional IRA, you may be able to reduce the amount of yearly federal income taxes you pay while you're working. With a Roth IRA, you reduce the taxes you pay while you're retired. Any contribution you make to a SIMPLE IRA also gives you a break on your current taxes.

Traditional IRA

With a traditional IRA, you may deduct the amount you deposit from your taxable income. At time of publication, you can deduct for up to $5,000 if you are under 50 and $6,000 if you turn 50 before the end of the year. If you are older than 70 1/2, you no longer qualify for the deduction, but you're also more likely to be taking money from your account rather than putting in money.

Income Restrictions

You can only use money from taxable income earned "such as wages, salaries, commissions, tips, bonuses, or net income from self-employment," to get the tax benefit, the IRS says. You don't have to pay tax on the interest or dividends your IRA earns until you withdraw the money.

Roth IRA

With a Roth IRA, you pay tax on the money in the year you deposit it into the account, but you don't pay tax on it in the years when you withdraw the money. The idea is when you're retired, you likely will be in a lower tax bracket because you don't have income from a job. And we all like a break from the IRS.

SIMPLE IRA

In a Savings Incentive Match Plan for Employees, your employer is allowed to match the amount of money you put into the IRA up to 3 percent of your annual earnings. Because the money your employer contributes goes directly into your IRA, you don't need to pay tax on it until you retire. The plan was originated by the government as an incentive for companies that don't have a retirement plan for their workers and have fewer than 100 employees.

 

About the Author

Richard Asmus was a writer and producer of television commercials in Phoenix, Arizona, and now is retired in Peru. After founding a small telecommunications engineering corporation and visiting 37 countries, Asmus studied broadcasting at Arizona State University and earned his Master of Fine Arts at Brooklyn College in New York.

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