Contributing up to the annual limit to your individual retirement account can lower your taxable income or get you a tax credit. However, excess contributions will hurt you on your tax return. As of 2012, the maximum yearly IRA contribution is $5,000, or $6,000 if you're age 50 or older.
Traditional IRA contributions may be deductible and lower your adjusted gross income for the year. However, not everyone qualifies for this. If neither you nor your spouse is covered by a retirement plan at work, you're not eligible to deduct your contribution if your modified adjusted gross income is too high. For example, in 2012, if you're single and participate in an employer plan, your deduction starts decreasing when your income exceeds $58,000. If it exceeds $68,000, you can't deduct your contributions.
Because Roth IRA contributions are made with after-tax money, they aren't deductible. They won't decrease your taxable income, no matter what your income or employer-plan status. Instead of getting a tax break for contributing, you take qualified distributions tax-free. So, Roth contributions won't show up on your tax return. However, Roth contributions can qualify for the retirement savings credit.
Retirement Savings Credit
Traditional and Roth IRA contributions qualify as eligible contributions for figuring the retirement savings credit. This credit equals up to 50 percent of the first $2,000 of eligible contributions per person, or up to $4,000 of contributions on a joint return. However, your income must fall below the limits for your filing status, which adjust annually. In addition, you can't claim the credit if you're under 18 years old, a full-time student or claimed by someone else as a dependent.
Contributing more than you're allowed is a detriment to your tax return. You'll owe a 6 percent penalty on each dollar of excess contributions each year that you don't correct it. If you think you're eligible to contribute but aren't, the penalty still applies. For example, if your modified adjusted gross income exceeds the annual limits for a Roth IRA but you contribute anyway, each dollar you put in is an excess contribution.
- Comstock/Comstock/Getty Images