Pre-tax individual retirement arrangements, also known as traditional IRAs, usually give you the option of deducting your contributions to the account. The money grows tax-free in the account, and then is taxed when you take distributions. This type of account is particularly valuable if you anticipate paying a lower tax rate in the years you take distributions. However, not everyone qualifies to claim a tax deduction.
No Employer Plan
Your income doesn't affect your ability to deduct your contribution to a pre-tax IRA if you don't participate in an employer-sponsored retirement plan. If you're married, your spouse must also have no employer-sponsored plan in order for your deduction eligibility to be absolute. Examples of employer-sponsored plans include 401(k)s, 403(b)s and 457 plans. If you are covered, your Form W-2 will have an "X" under "Retirement Plan" in box 13.
If you or your spouse is covered by an employer plan, you might not be able to deduct your pre-tax IRA contribution if your income exceeds the annual limit. The IRS publishes the updated limits each year in Publication 590 and they vary depending on your filing status. For example, if you're single, you'll have a much lower limit before you can't deduct your contribution to a pre-tax IRA than if you're married filing jointly and only one of you is covered by an employer plan.
If your modified adjusted gross income falls in the phaseout range, you have to figure a reduced deduction limit for the year. The higher your income is in the phaseout range, the smaller your maximum deductible contribution. For example, if your modified adjusted gross income is halfway between the upper and lower limits of the phaseout range, you'd only be able to deduct half the amount of your maximum contribution. If you contribution limit is $5,000, that would mean you could make a $2,500 deductible contribution.
Just because you can't make a deductible contribution to your traditional IRA doesn't mean you can't put any money in at all. Though you can't deduct your contribution, you can still make a nondeductible contribution to the pre-tax IRA and the money will still grow tax-free while it remains in the IRA. Then, when you take distributions, the earnings will be taxed, but the nondeductible contributions come out tax-free. Instead of making a nondeductible contribution to a traditional IRA, you may be able to consider a Roth IRA if you're eligible: all qualified distributions, including earnings, come out tax-free. If your income is too high to contribute to a Roth IRA, you may also be able to make a nondeductible traditional IRA contribution and roll it over to a Roth IRA.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."