IRA Contributions: Deductions
The primary benefits of contributing to an IRA are the possible tax deductions, the tax-deferred or tax-free growth on earnings and, if you are eligible, the non-refundable tax credits. To get the most out of contributing to your IRA, it's important to understand what these things mean and the regulations placed on them.
Receiving a Tax Deduction
If you do not participate in an employer-sponsored plan, such as an SEP IRA, SIMPLE IRA or qualified plan, contributions to your Traditional IRA may be tax deductible. However, if you participate in either of these plans, you are considered an active participant, and the deductibility of your contributions are determined by your modified adjusted gross income (MAGI) and your tax-filing status, that is, whether you file 'married filing separately', 'married filing jointly' or 'single'. (See Traditional IRAs for more details.)
If your Traditional IRA contribution is not deductible, you may still make a non-deductible contribution to it. Alternatively, you may contribute to a Roth IRA, providing your MAGI satisfies the Roth-IRA eligibility limits. (See Roth IRAs for more details.)
If your income falls between the ranges that allow only a partial contribution, you may use a special formula to determine that partial contribution.
Tip: If you are married, but you lived apart from your spouse for the entire year, you are not treated as married for tax-filing purposes. Therefore, you would fall into the 'single' category.
Should you decide to make a nondeductible contribution to your Traditional IRA, be sure to file IRS Form 8606, which helps you and the IRS keep track of the non-taxable balance in your Traditional IRAs, ensuring you do not pay taxes on distributions that should be tax-free. You can find the year's current Form 8606 at www.irs.gov.
Splitting Your Contribution
Splitting your contribution between your Traditional and Roth IRA may be beneficial in certain circumstances:
- You are eligible for only a partial deduction on your Traditional IRA. Instead of contributing the nondeductible amount to a Traditional IRA, where earnings grow tax-deferred, you can contribute the amount to a Roth IRA where earnings grow tax-free.
- You are eligible for only a partial Roth-IRA contribution. To maximize your contribution for the year, you can contribute the difference to your Traditional IRA.
Tip: Your combined contribution to your Roth and Traditional IRA should not exceed the IRA contribution limit, which for 2007 is $4,000 plus $1,000 catch-up contribution and 2008 is $5,000 plus $1,000 catch-up contribution.