Individual retirements accounts (IRAs) are designed to help individuals plan for their retirement. They are long-term investment vehicles that can be invested into over decades before the funds are eligible for penalty-free withdrawal. One of the biggest boons of these accounts is their tax advantages, which can offer various tax breaks on contributions and sometimes withdrawals. This can have an impact on how your gross income is taxed come tax season.
Traditional IRA
The traditional IRA has the greatest impact on your income taxes--any contributions made to a traditional IRA are tax-deductible, helping you save a few dollars on your taxes owed or increasing your refund amount. Taxes are then paid on your withdrawals from your traditional IRA, which may not be for several years. Many people prefer this type of IRA because the tax break is enjoyed on the front end of the investment. It can also save money from your highest tax bracket--for example, if you are in a 25 percent tax bracket, you will save having to pay 25 percent of the value of your IRA contribution in that tax year on your taxes.
Roth IRA
The Roth IRA is not tax-deductible for investors, making it a helpless investment when trying to save on your taxes. However, since the Roth IRA is taxed initially, all withdrawals made when the account matures are tax-free. In the long run, this can save a significant amount of money on your tax returns compared to a traditional IRA.
Retirement Plan Complications
When you have a retirement plan provided by your employer, how your traditional IRA contributions are factored into your income taxes can differ. The determining factor is your modified adjusted gross income (MAGI), which only allows contributions based on income brackets. Individuals making less than $55,000 annually are eligible for the full deduction of your traditional IRA contributions, but only a percentage of your contributions are tax-deductible if you earn between $55,000 and $90,000. The IRS uses a MAGI formula based on your marital status, age and income level when determining the amount of the contribution for which you are eligible, but only when you already have retirement plan benefits.
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