A traditional individual retirement account allows you to open and contribute to your own tax-advantaged retirement plan without relying on an employer. You can usually write off contributions on your tax return and may get a tax credit as well. The amount of money you save on taxes depends on your income tax rate, how much you contribute and whether you qualify for the Retirement Savings Contributions Credit, also called the Saver's Credit.
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Writing Off Contributions
The Internal Revenue Service limits the amount you can contribute annually to an IRA. For example, in 2018 the maximum is $5,500. At age 50, this increases to $6,500. Rollovers, meaning funds transferred from another retirement plan like a 401(k), don't count as contributions. Traditional IRA contributions are usually tax-deductible. Suppose you add $5,500 to your traditional IRA and you are in the 25 percent tax bracket. The deduction cuts your taxes by 25 percent of $5,500, or $1,375.
The IRS sets income limits for tax-deductible contributions to traditional IRAs, but only when you, or your spouse if you are married, have a retirement plan offered through an employer. There is no income limit when you and your spouse aren't covered. For single filers covered by retirement plans at work in 2018, the deduction began to phase out when adjusted gross income reached $62,000 and became zero at an AGI of $72,000. The phase-out range for a married person filing a joint return was $99,000 to $119,000. The IRA started to phase out with the first dollar of income for a married person filing separately and was gone when AGI equaled $10,000. If you were married, filed a joint return and your spouse was covered at work and you were not, the phase-out occurred from an AGI of $186,000 to $196,000.
Calculating Reduced IRA Deductions
When your adjusted gross income lies in the IRA deduction phase-out range, you can still save some money on taxes with a partial write-off. To figure out how much, start with the phase-out range. Suppose you are single. The deduction phases out as AGI increases from $62,000 to $72,000, so the range amount is $10,000. If your AGI is $66,000, $4,000 falls in the phase-out range. Divide $10,000 into the $4,000 and you get 40 percent. The amount you can deduct is reduced by 40 percent to 60 percent of $5,500, or $3,300. You may still contribute the remaining $2,200, but you can't write it off on your taxes.
The Saver's Credit
The Saver's Credit is open to taxpayers with modest incomes to help them fund retirement accounts like 401(k) plans and IRAs. The credit can be up to $2,000. A married couple filing jointly can get up to $4,000. As a tax credit, the amount is subtracted directly from your tax liability, so the size of the credit equals your tax savings. The credit is on top of any savings from writing off contributions. As of 2018, the amount of the credit was 50 percent of the amount you contributed if you were single and your AGI was not more than $19,000. For couples filing a join return, the AGI limit increased to $38,000. You could claim a Saver's Credit of 20 percent of contributed money if you filed as single with an AGI between $19,001 and $20,500 and 10 percent as long as your AGI remained at $31,500 or less. For married couples filing joint returns, the 20 percent range went from an AGI of $38,001 to $41,000. The 10 percent range started at $41,001 and went up to $63,000.