IRAs qualify for important tax benefits that encourage long-term saving and investing. Unless you strictly limit your IRA investments to insured CDs and other types of risk-free savings, you face the possibility of taking a loss on an investment. Traditional IRAs give you no way to claim a loss on investments, but you might be able to get a deduction for Roth IRA losses.
You can make tax-deductible contributions to a traditional IRA. In 2013, the IRS limits the amount you can kick in to the lesser of your income and $5,500 a year -- or $6,500 if you’ve reached age 50. Normally, you can deduct the full amount unless you or your spouse are covered by a qualified employer retirement plan. In 2013, deductions for single filers covered at work begin to decrease when your modified adjusted gross income exceeds $59,000. Once you hit a MAGI of $69,000, you get no deduction. For couples filing jointly, the beginning and ending thresholds are $95,000 and $115,000 if you are covered by a plan at work. If only your spouse is covered, the thresholds for joint filers are $178,000 and $188,000.
Traditional IRA Losses
The tax deductions for the money you squirrel away in a traditional IRA are balanced by the taxes you pay when you take money out. The IRS taxes all your deductible contributions and earnings at your marginal tax rate -- the amount you owe on the “last dollar” of annual income. Any losses from the sale of a mutual fund or any other investment reduces the amount of money you have to withdraw, and in that sense lowers your total tax liability. However, you cannot deduct losses in your IRA on your tax return. If you siphon money out of a traditional IRA before age 59 1/2, the Internal Revenue Service might slam you with a 10 percent penalty for early withdrawals. You must begin taking required minimum distributions when you reach age 70 1/2.
You don’t get a tax-deduction by kicking money into a Roth IRA, but if you follow the rules, you can withdraw all your money tax-free. The rules include a five-year waiting period and reaching age 59 1/2 to avoid a 10 percent tax on early withdrawals of earnings -- unless you qualify for an exception, such as total disability. You can remove your contributions at any time without penalty, although you then lose their tax-free earning power. In 2013, the IRS begins to reduce the amount joint filers can contribute to a Roth IRA when MAGI reaches $178,000 and bans contributions if you hit the $188,000 mark. For single filers, the MAGI thresholds are $112,000 and $127,000. Roth IRAs have no required minimum distributions.
Roth IRA Losses
As with traditional IRAs, you cannot deduct losses within a Roth IRA, but you might get a deduction if you close your Roth IRA at a loss. Your Roth’s “cost basis” is the total money you’ve poured into the account. If you close your Roth and receive less than your cost basis, the loss might be deductible. You must add the loss to all your other miscellaneous deductions and can only deduct the amount that’s greater than 2 percent of your adjusted gross income.
For example, suppose a loss from a mutual fund sale in your Roth IRA lowers its balance to $15,000 despite the $25,000 you contributed. You can close the account and have a $10,000 loss. If that is your only miscellaneous deduction and your adjusted gross income is $50,000, the 2 percent threshold is $1,000, leaving you with a $9,000 tax deduction. You must itemize your deductions and fill out Form 1040 and Schedule A to claim the deduction.
- Internal Revenue Service Publication 590: Individual Retirement Arrangements
- Internal Revenue Service: 2013 IRA Deduction Limits - Effect of Modified AGI on Deduction if You Are Covered by a Retirement Plan at Work
- Internal Revenue Service: 2013 IRA Deduction Limits - Effect of Modified AGI on Deduction if You Are NOT Covered by a Retirement Plan at Work
- Internal Revenue Service: Amount of Roth IRA Contributions That You Can Make For 2013
- Turbotax: Are Losses On A Roth IRA Tax Deductible?
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.