Why You Can’t Always Take a Tax Deduction on an IRA

 On deadline day for filing your taxes, you may be considering making last-minute Traditional IRA contribution.  Most people contribute to an IRA to 1) save for retirement and 2) take a tax deduction on the contribution to hopefully lower one’s overall tax bill.  Many people, however, are not aware that there is a good chance that the IRA contribution they are intending to make or have made in the past, does not allow for a tax deduction. This happens if you are above IRS adjusted gross income (AGI) thresholds.  Eligibility to deduct depends on income and whether or not you are covered under an employer sponsored retirement plan, such as 401k or 403b.

Married Filing Jointly

Both spouses are covered under an employer sponsored retirement plan at work

  • Income limit to be able to fully deduct an IRA contribution - $96,000

Only one spouse is covered under an employer sponsored retirement plan at work

  • Income limit to be able to fully deduct an IRA contribution - $181,000

Neither spouse is covered under an employer sponsored retirement plan at work

  • No income limit to be able to fully deduct an IRA contribution

Single

Individual is covered under an employer sponsored retirement plan at work

  • Income limit to be able to fully deduct an IRA contribution - $60,000

Individual is not covered under an employer sponsored retirement plan at work

  • No income limit to be able to fully deduct an IRA contribution

There’s a reason the IRS limits the amount that can be deducted by someone who is covered under an employer retirement plan. The IRS tries to prohibit investors who are in higher tax brackets from sheltering “too much” income that won’t be taxed until funds are ultimately withdrawn upon retirement. 

You must also have earned income equal to or greater than the IRA contribution being made during the year in which the contribution will be coded.  For example, for someone to be eligible to make a full IRA contribution, their earned income from work throughout the year must be greater than or equal to $5,500, if under the age of 50, or $6,500 if over the age of 50.  Another important note – Social Security, pension benefits, IRA distributions, dividends, interest, etc. are NOT considered earned income items.  The IRS prevents retirees from contributing to qualified retirement accounts that grow tax-deferred unless they are working. 

In my next blog post, I’ll discuss ins and outs of contributing and withdrawing funds from an IRA where non-deductible contributions were made…this is where things can tricky.  Stay tuned. 

Nick Defenthaler, CFP® is a Support Associate at Center for Financial Planning, Inc. Nick currently assists Center planners and clients, and is a contributor to Money Centered and Center Connections.


The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. C14-009199