If you don't have a retirement plan at work, you aren't out of luck when it comes to saving for retirement. Using an individual retirement arrangement to save for your retirement can save you on your income taxes, but the amount of the savings depends on your total income and the type of IRA to which you contribute.
Deduction for Contributions
Only some contributions to traditional IRA contributions result in a tax deduction. If you and your spouse don't have retirement plans through your employer, you can always deduct your traditional IRA contribution. Employer plans include 403(b) plans, 401(k) plans or 457 plans. However, if either of you are covered, you can't deduct your contribution if your income exceeds the annual limits, according to IRS Publication 590. Contributions to Roth IRAs never result in an income tax deduction.
The IRS classifies the deduction for an traditional IRA contribution as an adjustment to income, which means that you can claim the tax break without itemizing your deductions and giving up the standard deduction. The amount that you save from your contribution equals your deduction amount times your marginal tax rate. For example, if you pay a 15 percent marginal tax rate, a $6,000 deduction only saves you $900. However, if you pay a 30 percent marginal tax rate, that same contribution saves you $1,800.
Marginal Tax Rate
The federal government uses a progressive income tax structure, which means that as you have more taxable income, you pay a higher tax rate. Your marginal tax rate refers to the rate you pay on your last dollar of taxable income. For example, assume the 20 percent tax bracket goes up to $40,000 and income over $40,000 is taxed at 25 percent. If you have $43,000 of taxable income, your marginal tax bracket is 25 percent, because the last $3,000 of your income is taxed at 25 percent.
Retirement Savings Credit
Regardless of whether your IRA contribution reduces your taxes through a deduction, it may reduce your taxes with the retirement savings credit. Both contributions to traditional and Roth IRAs qualify for the credit. However, your income must fall under the annual limits, which differ depending on your filing status. In addition, you have to be over 18 years old and you can't be a full-time student. Depending on your income, the credit can be as high as 50 percent of your contribution, up to $1,000 ($2,000 if you file a joint return and both spouses contribute).
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