What Kind of IRA Contributions Can Be Deducted When You Have a Retirement Plan?
If you participate in an employer-sponsored retirement plan at work, you may be able to deduct certain types of Individual Retirement Account, or IRA, contributions if you want to save on your own, as well. As an individual, you can deduct both traditional or Simplified Employee Pension, called SEP, IRA contributions. You can also contribute to a Roth IRA, although the Internal Revenue Service does not give you a deduction for doing so.
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Traditional IRA Deductions
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As of 2010, you can contribute up to $5,000 to a traditional IRA if you are under 50, and $6,000 if you are 50 or older. If you do not participate in an employer-sponsored retirement plan, you can deduct the full amount of your contribution from your income. If you do participate in an employer-backed plan, the IRS imposes income limits that may reduce or eliminate your deduction.
For instance, if you are married, filling jointly in 2010, you can deduct the maximum traditional IRA contribution if you make less than $89,000. If you make between $89,001 and $109,000, you can take a reduced deduction. If you make over $109,000, you cannot deduct your traditional IRA contribution. There are separate limits for single filers and those who are married, filing jointly. Income limits are subject to change annually.
SEP IRA Deductions
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SEP IRAs serve a dual purpose: small employers can set them up for their employees and make contributions to the accounts on their employees' behalves. Or, you can set up a SEP IRA to set aside money you earn from self-employment or a small business. If your employer offers a SEP IRA plan and you are self-employed, you can own two SEP IRAs. As of 2010, you can aside up to 20 percent of your self-employment income or $49,000, whichever is smaller. In all other respects, SEP IRAs function like traditional IRAs: you can deduct your contributions from your income.
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Roth IRAs
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You cannot deduct Roth IRA contributions, but they can be a smart retirement savings tool nevertheless. Roth IRAs are attractive because qualified withdrawals are tax free. Like traditional IRAs, you cannot contribute more than $5,000 if you are under 50 and $6,000 if you are older. Roth IRAs also have income limits; but, as you cannot take a deduction for a Roth IRA contribution, these limits phase you out of contributing to a Roth IRA altogether. The limits apply whether or not you are covered by a retirement plan at work.
As of 2010, a person who is married, filing jointly, can contribute the maximum amount if the couple's joint income is less than $167,000. Individuals whose joint income does not exceed $177,000 can make a reduced contribution; those who make more are ineligible to contribute to a Roth IRA.
Considerations
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The same annual contribution limit applies to Roth and traditional IRAs. This limit does not represent how much money you can contribute to each type of account; rather, it is the maximum total amount you can contribute. For instance, if you have both a Roth and a traditional IRA and are 30 years old in 2010, contributions to your accounts cannot exceed $5,000. Therefore, you could contribute $2,500 to each or $3,000 to one and $2,000 to the other; but not $5,000 to both.
Similarly, you must subtract amounts you contribute to a SEP IRA from the IRS' Roth and traditional IRA contribution limit. In 2010, if you were subject to the $5,000 contribution limit, you could not contribute to a Roth or traditional IRA if you contributed $5,000 or more to a SEP IRA.
Benefits
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Contributing to an employer-sponsored retirement plan and a traditional, SEP or Roth IRA is a smart way to maximize your tax-sheltered retirement savings. If you don't have the money to max out your employer retirement plan and your own IRA, consider where you'll get the most for your contribution. For instance, if your employer matches 401k contributions, you might want to contribute the full amount to your work plan before contributing to an IRA.
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References
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