There is no time like the present to get started when it comes to socking away money for your retirement years. You can contribute up to $5,000 into your individual retirement account each year, as of the 2011 tax year. Your contributions to a traditional IRA are tax deductible, but they are not part of your itemized deductions.
Traditional vs. Roth
Contributions you make to your IRA may or may not be tax deductible, depending on whether you have a traditional IRA or a Roth IRA. You can take a tax deduction for contributions to a traditional IRA, and your funds are allowed to grow tax-deferred until you withdraw them after you reach retirement age. All withdrawals from your traditional IRA are taxed as ordinary income. You can't take a tax deduction for contributions to a Roth IRA, but your funds are allowed to grow tax-free. All qualified withdrawals from your Roth IRA are free from federal income taxes.
Don't include your contributions to your IRA with your itemized deductions. Instead, report your contributions to your traditional IRA on Line 32 of IRS Form 1040. You deduct the amount of your contribution from your total income to determine your adjusted gross income. Since you can't take a tax deduction for contributions to your Roth IRA, there is no need to report them to the IRS, unless you are converting from a traditional IRA or rolling over funds from another qualified retirement plan. Report conversions and rollovers on IRS Form 8606.
In rare instances you may be able to claim losses incurred in your IRA as a miscellaneous deduction if you choose to itemize your deductions. You can only claim a loss once you have completely liquidated all of your same-type IRAs and the combined losses outweigh any gains. The loss is subject to the same 2-percent rule as all other miscellaneous deductions, that is, only the amount of your miscellaneous deductions that exceed 2 percent of your adjusted gross income is deductible. Since this situation usually only happens after you retire and drain your IRA accounts, it is unlikely that you will encounter this situation.
One benefit of both traditional and Roth IRAs is the accessibility of funds. All of the money in your IRA belongs to you, and you have the right to withdraw your money from your IRA at any time, for any reason. Withdrawals of amounts equal to your contributions to your Roth IRA will not result in any tax consequences, since you have already paid taxes on those funds. Early withdrawals from your traditional IRA and non-qualified withdrawals of the earning portion of your Roth IRA will be taxed as ordinary income and will also be subject to a 10 percent early withdrawal penalty. Unlike early withdrawal penalties on bank savings accounts, the tax penalty on early IRA withdrawals is not tax deductible.
- Internal Revenue Service: Publication 590 -- Reporting Deductible Contributions
- Internal Revenue Service: Publication 590 -- Early Distributions
- Internal Revenue Service: Publication 590 -- Recognizing Losses on Investments
- TurboTax: Are Losses on a Roth IRA Tax Deductible?
- Internal Revenue Service: Form 1040 (PDF)
- Internal Revenue Service: Publication 529 -- Deductions Subject to the 2% Limit
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.