Can You Take an IRA Deduction?

If you contribute to a traditional IRA in 2014, you could qualify for a deduction on your next tax return. However, not everyone qualifies for a deduction. As with lots of other tax breaks, there are income limits, but your income is not the only factor. Here's a quick guide to help you determine if you can take an IRA deduction or if you would be better off taking another route with your retirement savings.

Are you eligible to participate in a plan at work?
Basically, the traditional IRA tax deduction is intended to help people who can't participate in an employer-sponsored retirement plan, such as a pension plan or 401(k), both of which generally take contributions from your paycheck on a pretax basis.

So, if you or your spouse is eligible to participate in a plan at work, your ability to take an IRA deduction on your taxes is more limited. The actual income limits depend on whether you have a spouse and/or have an employer-sponsored plan.

If your employer doesn't offer some sort of retirement plan, you are eligible to deduct the maximum allowable contribution to a traditional IRA regardless of your income. The maximum IRA contribution is $5,500 for the 2014 tax year, or $6,500 if you're 50 years of age or older.

What's the income limit for your scenario?
For single taxpayers, the income limit to making a full IRA deduction is $60,000 for the 2014 tax year if you have a retirement plan at work. The ability to take the deduction begins to phase out for incomes above $60,000 and is eliminated entirely above $70,000.

For married couples filing jointly, if both spouses are covered by employers' plans, the maximum income for a full deduction is $96,000, and the deduction phases out between that amount and $116,000. If only one spouse is covered under a plan at work, the couple can earn up to $181,000 and still qualify for a full deduction and can claim a partial deduction with as much as $191,000 in annual income.

What if you don't qualify for the tax break?
If your income is too high to deduct traditional IRA contributions on your taxes, consider the Roth IRA as an alternative. Basically, instead of giving you a tax benefit now in the form of a deduction, a Roth IRA allows you to withdraw your money tax-free once you reach retirement age.

The income limits for Roth IRA contributions are a little more generous than they are for traditional IRA deductions. Single taxpayers earning less than $114,000 can contribute the maximum amount, and their contribution limit dwindles to zero as their income climbs to $129,000. Married couple earning less than $181,000 together can contribute the maximum, and their ability to contribute phases out between that level and $191,000.

If your income makes you ineligible to contribute to a Roth IRA directly, there is an alternative way. Basically, the "backdoor" method of contributing to a Roth IRA consists of contributing to a traditional IRA (which anyone can do regardless of income, though perhaps without the deduction) and immediately convert your account to a Roth IRA. A thorough description of the process can be found here, but the tax benefits make the effort well worth it.

Another option is to contribute more to your employer's plan on a pretax basis. The actual amount you can contribute varies based on the type of plan and your age, and a full guide to 401(k) limits is available from the IRS. The amount your employer matches is usually capped at much less than the maximum, but any contributions above and beyond the employer-match limit are still withheld on a pre-tax basis. This produces pretty much the same effect on your tax liability as a traditional IRA deduction.

Do your homework
he best thing you can do for your retirement is to take advantage of all of the free money (from employer matching) and tax benefits offered to you. Whether you choose to take your tax benefits now or in retirement is your own choice, but choose one option and contribute as much as you can. You'll be glad you did later!

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Matthew Frankel

Matt brought his love of teaching and investing to the Fool in order to help people invest better, after several years as a math teacher. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!

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