IRA contributions can affect your taxes in serious ways

How IRA Contributions Affect Your Taxes

One important element to look into when it comes to your investment strategy is how it affects your taxes. There are different variables that come into play, and the last thing you want is to end up paying large sums of taxes that cut into the overall value of your investments. IRA are traditional investment accounts, so this is money you don't see for decades to come. With that being said, you don't want your retirement consumed by Uncle Sam, so you need to know exactly how IRA contributions affect your taxes.

For starters, a traditional IRA has a deductibility limit. When you make a contribution to your traditional IRA, you can claim a tax deduction for the contribution you make as long as both yourself, and any spouse is actively participating in the investment (this means you are not able to double your tax contributions when using both you and your spouse's account, should your spouse not contribute anything into the IRA). However, you are not able to deduct all of your contributions from your net income. To determine exactly what contributions you can deduct, you need to determine your modified adjusted gross income and your overall filing status. Once this is determined, you can see how much you can deduct from your net income when paying taxes.

Currently in 2014, if you are 49 or under, you can deduct $5,500 from your net income. If you are 50 or older, you can claim $6,500 from your net income. Any money you contribute to your retirement fund is above the allotted amount and still counts as income. Outside of the additional amount you pump into your IRA, you really are not going to feel any sort of tax hit while you are contributing to your IRA account. However, you are going to have to pay taxes later on, when you start withdrawing money from the account. When claiming the deduction, you don't need any sort of special paperwork on your taxes at all. You just need to fill in the information directly onto your 1040 or 1040A form.

By the time you start drawing on your IRA account, the non-taxable income is now taxable. However, you don't pay a lump tax on all the money you have in your retirement account. This would drastically reduce the amount of money you have to live off of by a significant amount. Instead, you only pay taxes on the amount you withdraw.  If, over the course of a year, you draw $30,000 from your IRA account. This $30,000 is seen as income, and it is taxed as such. The overall amount of money you have to pay on your taxes ultimately depends on the tax bracket you fall into. Due to this, you need to be well aware of what bracket you could potentially fall into while making deductions. You don't want to end up in a higher bracket, simply because you are over by $10. Either way though, you are taxed just like any other income.

Last Updated: February 23, 2017