Looking for an IRA Tax Deduction? Know the IRA Types & Tax Considerations

Stashing money away for your retirement is a wise, even necessary, thing to do. So, as you consider saving for your future, you might want to look at retirement vehicles that offer tax advantages. Some accounts offer tax advantages for the year that you make your contributions; others offer tax breaks much laterwhen it’s time to withdraw the funds.

Are IRA contributions tax deductible?

A simple way to potentially benefit from tax advantages is to contribute to an individual retirement account (IRA), which can provide an IRA tax deduction or tax-exempt retirement withdraws. However, there are different types of IRAs to choose from, each with different tax benefits, rules, and limitations.

What differentiates these account types? Which type of IRA might be right for you? Let’s dive in and take a closer look at two IRA types.

Traditional IRA tax deduction

A traditional IRA allows you to make annual contributions that you may be able to claim as an IRA tax deduction. Instead of paying taxes on the money you contribute now, you defer those tax payments until retirement, at which point you pay taxes on your withdrawals. Even if you cannot deduct your IRA contribution, any earnings grow tax-deferred. This means you are not taxed on your earnings until they are withdrawn.

As long as your IRA contributions don’t exceed your annual earned income, the amount you can contribute to your traditional IRA is as follows:

• If you’re under the age of 50, you can contribute as much as $6,500 in 2023.
• If you’re 50 or older, you can benefit from the $1,000 IRA “catch-up” rule, which allows you to contribute as much as $7,500 for 2023.

You can contribute to a traditional IRA up to your filing deadline, which this year is April 15, 2024, for the 2023 tax year. Your total contribution is fully deductible if neither you nor your spouse are covered by a workplace retirement plan. Traditional IRA tax deductions typically reduce your tax bill for your tax filing year, which is a benefit to you immediately.

If you’re covered by a workplace retirement plan, then your IRA contribution may be fully or partially deductible depending on your modified adjusted gross income (MAGI), which is your gross income minus any deductions. Once your MAGI exceeds a certain amount, the amount of deductions you can take for IRA contributions lowers. Here’s how the phaseout works:

• If you’re a single filer, your phaseout range for tax year 2023 was $73,000 to $83,000.
• If you’re a joint filer, your phaseout range for 2023 was $116,000 to $136,000. 

For those who are married and file taxes jointly, if you’re not covered by a workplace plan, but your spouse is, then the income phaseout range is higher. That’s good news because you may still be able to take an IRA deduction depending on your MAGI. For 2023, your IRA contribution could be:

• Fully deductible if your MAGI is $218,000 or below
• Partially deductible if your MAGI is more than $218,000 but less than $228,000

It’s important to be aware of the changes to the required minimum distributions, or RMDs, for traditional IRAs under the SECURE Act. Previously, RMDs had to begin in the year you turn 70 1/2, but the SECURE Act increased the age to 73. You could incur steep penalties if you fail to make the required withdrawals from your traditional IRA—as much as 50% of the amount you should have withdrawn. In addition, if you withdraw funds from a traditional IRA before age 59 1/2, you’ll be subject to a 10% early withdrawal penalty. Plus, your funds will be taxed as regular income.

Note that the age limit for making IRA contributions has been removed starting in 2020, provided you have earned income. You may continue to make IRA contributions even if you are also taking RMDs.

(If you happen to be a small business owner or self-employed, you can use a SIMPLE IRA plan or Simplified Employee Pension (SEP) to save up for retirement. There are also plenty of other retirement plans available for self-employed entrepreneurs.)

Roth IRA tax deduction

A Roth IRA has many features similar to a traditional IRA, but its tax advantages are different. Essentially, contributions to a Roth IRA are not tax deductible when you file taxes for the year. Instead, Roth IRA contributions provide tax-free income on all your withdrawals and earnings once you’re in retirement.

So, when choosing between a traditional and Roth IRA, it’s a matter of deciding whether you think it’s best to pay taxes now, at your current tax rate, or later when you’re retired. Also do you want tax-free income in retirement? Keep in mind that under the current law, your taxable income during retirement can affect a number of expenses, such as your Medicare premium. By providing nontaxable income, a Roth IRA has the advantage of not increasing expenses like your Medicare premium while distributions from your traditional IRA might.

Also, a Roth IRA does not carry an RMD for withdrawal like a traditional IRA does. However, like a traditional IRA, you’ll incur a 10% penalty for early withdrawal of earnings (contributions can be taken out anytime) or before age 59 1/2 (Roth IRAs must also be at least five years old to avoid the penalty if withdrawing earnings).

Your contribution limits for a Roth IRA tax deduction are the same as those for a traditional IRA. But the amount you can contribute will begin to phase out once you reach a certain income. Here are the phaseout limits:

• For single filers, Roth IRA contributions for tax year 2023 begin phasing out at $138,000 and are ineligible at $153,000.
• For joint filers, Roth IRA contributions for 2023 begin phasing out at $218,000 and are ineligible at $228,000.

If you’ve made the transition from being employed to self-employed, or if you’ve experienced a significant drop in income and hence a drop in tax rates, you might want to look into how converting to a Roth IRA could benefit you because you’d possibly pay lower taxes up front.

Keep in mind that under these tax laws, you may no longer reverse a rollover into a Roth IRA. So, if you made a conversion or rollover into a Roth IRA after January 1, 2018, you’re stuck with it. 

Note there are a few more rules that apply to the phasing out of both your IRA contribution and deductibility. To learn more about tax year 2023, visit the IRS.gov page for 2023. You can also visit the TD Ameritrade page on IRA and Roth IRA rules, or contact a tax consultant.

Want more detailed information about IRAs? The TD Ameritrade IRA Guide offers plenty of useful information to help you decide what’s best for your retirement goals.

TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.