Pages

Labels

Thursday, February 10, 2011

Tax Deductibility of IRA Contributions

Tax deductibility of Individual Retirement Accounts (IRA's) is one of the primary features of these types of investments. These benefits can not only save a person and/or organization money, but also lead to greater income potential.

There are several types of IRA's and the tax benefits of each is unique. For individuals the benefits can mean added financial security in older age and for organizations/employers contributing to IRA's , the tax relief can lower payroll tax i.e. money paid to the Government. A brief description of various types of IRA's and the associated tax benefits are as follows:

• Traditional IRA: Contributions to traditional IRA's are tax deductible so long as the amount put into the account complies with federal tax regulations. This tax deduction lowers overall adjusted gross income allowing one to pay less taxes in a tax year or receive a larger tax return. Tax is applied to the contributions and earnings in this type of account at the time of withdrawal. Example: If monthly paychecks are $4,000/month, Monthly contribution from paycheck is $166.676therefore annual taxable income is reduced by $2000 saving $200 at the 10% income tax level.

• Roth IRA: Contributions are made from taxable income, however the withdrawals made after age 59.5 years of age are not taxed and neither are the earnings generated through the Roth IRA. Example: An individual contributes $4000/year to a Roth IRA, that contribution is not deductible, but over 10 years the 4K per year earns 10% each year. Compounded, the 10% tax free earnings yield ($74,124.67-$44,000)=$30,124.67. The $30K in tax free earnings saves one $4500.00 in taxes.

• Employer IRA: Corporations that don't utilize a pension fund may elect to use an employer IRA. These IRA's are established by an employer therefore are tax deductible for them and reduce taxable income for the employee. The affect is generally the same for the employee as taxable income declines in both instances. The contributions and earnings acquired through this type of IRA are tax deferred i.e. taxable upon withdrawal.

• Spousal IRA: Similar to traditional IRA's if contributions are made before the annual IRS mandated deadlines, the contribution is tax deductible. To benefit from a spousal IRA, the filer's tax status should be married filing jointly.

• Keogh: Keogh plans are similar to IRA's but slightly different in the sense they are for the self employed, certain types of small businesses and employees of those businesses. This money can be rolled over into an IRA and contributions are tax deferred until time of withdrawal. Unlike IRA's, Keogh's are not tax deductible because the funds are taken from gross earnings rather than net earnings i.e. pre-taxable income.

IRA contributions vary in terms of maximum amount allowed. Generally the contributions range between $4-6000 per year with contributions in the upper end being reserved for older retirement planners. This contribution amount can have a marginal influence on final tax calculations, but can be all that is needed to lower one's tax bracket from 20% to 15%.

What's more, not all contributions are deductible depending on one's income range. For Roth IRA's and Spousal IRA's incomes over 160K are either non-existent in the former, and not allowed in the latter. While an individual may own more than one IRA there are tax limits on the amount that is deductible i.e. $2000.00/year if filing singly and $4000.00 if married filing jointly.

0 comments:

Post a Comment