Deductions vary depending on your modified adjusted gross income (MAGI) and whether or not you are covered by an at-work retirement plan. If you (and your spouse, if applicable) are not covered by an employer retirement plan, your traditional IRA contributions are fully tax-deductible. If you (or your spouse, if applicable) are covered by an employer retirement plan, you can still make contributions to a traditional IRA, but depending on your income, they may qualify as partially tax-deductible or fully non-tax-deductible IRA contributions. You may be able to claim a deduction on your individual federal income tax return for the amount you contributed to your IRA.
Your traditional IRA contributions may be tax-deductible. The deduction may be limited if you or your spouse are covered by a retirement plan at work and your income exceeds certain levels. A non-deductible IRA is a traditional IRA that is not tax-deductible. Investments within a non-deductible IRA benefit from tax-deferred growth.
At retirement age, you can withdraw your contributions without paying taxes on them. If your income is too high to deduct contributions to a traditional IRA, you may qualify for a Roth IRA. However, contributions to a Roth IRA are not tax-deductible. Roth IRA contributions are still a long-term investment in a retirement savings plan.
In general, if you think you'll be in a higher tax bracket when you retire, a Roth IRA may be the best option. If you're covered by a company plan, a second test decides how much of your IRA contribution you can deduct. A traditional IRA is an individual retirement account that you can contribute money to before or after taxes, giving you immediate tax benefits if your contributions are tax-deductible. Even if you think the market is overvalued, it's generally worth making the maximum contributions to your IRAs.
Most brokerages act as custodians of Roth IRAs and traditional IRAs with the same minimums, fees and terms for each. However, you may not be able to deduct all of your traditional IRA contributions if you or your spouse participate in another retirement plan at work. If you withdraw money from a traditional IRA before age 59 and a half, you'll pay taxes and a 10% early withdrawal penalty. This process is known as a “Roth Backdoor IRA” and allows the investor to contribute to a Roth IRA when their income is too high.
Your eligibility to contribute to a Roth IRA depends on your modified adjusted gross income (MAGI) and your filing status. Unlike a traditional IRA, you can withdraw sums equal to your Roth IRA contributions, penalties and tax-free, at any time, for any reason, even before age 59 and a half. If you expect to be in a lower tax bracket during retirement, a traditional IRA might be the most financially appropriate. With uncertain changes in tax laws, many investors choose the Roth IRA because they expect tax rates to rise in the future.
The main reason an investor can contribute to a non-deductible IRA is the ability to convert the account into a Roth IRA.