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Are IRAs tax deductible?
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| The Individual Retirement Account
(IRA) was once a popular tax deductible way to save for retirement but
lost much of its luster after Congress tightened eligibility requirements in the 1986 tax
law. But since the 1997 tax law changes took effect IRAs are worth taking a second look
at. Both you and your spouse can
take a tax deduction on your tax return for contributions to a regular IRA of up to
$4,000 ($5,000 if age 50 or over) or 100% (whichever is less) of wage, salary, or self employment taxable earnings if neither of you
have retirement plan coverage at work. Taxable alimony is included for the purposes of
determining taxable earnings. You have until April 15, 2007 to make your
2006 IRA contributions.
You must make your contributions by this deadline even if you get an extension to file
your tax return. You can only make contributions for years prior to your attaining age
70˝. On a joint tax return, provided you have taxable earnings of at least
$8,000, you and your
spouse can contribute $4,000 each to an IRA even if only one spouse works.
If either you or your spouse are an "active participant" in an employer
retirement plan or self employed retirement plan for any part of the plan
year you may not be able to make tax deductible IRA contributions. If you are an employee and
you were covered by an employer retirement plan the "Retirement plan" box inside
Box 13 of your Form W-2 will be checked.
An employer retirement plan is:
 | A qualified pension, profit sharing, or stock bonus plan, including a qualified
self employed Keogh plan, SIMPLE IRA, or simplified employee pension (SEP); |
 | A qualified annuity plan; |
 | A tax sheltered annuity; and |
 | A plan established for employees by the United States, a state or political subdivision,
or any agency or instrumentality of the United States or a state or political subdivision.
Eligible state Section 457 plans are not included as employer retirement plans. |
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| Phase-outs |
| If your phase-out threshold is... |
Your
tax deduction
phases out at...
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No
tax deduction
is allowed at...
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| $50,000 |
$50,001-$60,000 |
$60,000 + |
| $75,000 |
$75,001-$85,000 |
$85,000 + |
| $150,000 |
$150,001-$160,000 |
$160,000 + |
| $0 |
$0-$9,999 |
$10,000 + |
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Roth IRAs
You can make non tax deductible IRA contributions but you are probably better off contributing
to a Roth IRA instead. While both plans accumulate earnings tax free until withdrawal the
Roth IRA after five (5) years offers completely tax free withdrawals of earnings if you
are 59˝ or older, disabled, or you withdraw no more than $10,000 for first time home
buyer expenses.
Non tax deductible IRAs
These are basically non tax
deductible retirement savings accounts for people who don't qualify for the
tax deductible or Roth IRA. In these non tax deductible accounts, contributions are taxed but the earnings and
interest grow tax deferred. When it comes time to withdraw the money, you pay
tax on the
earnings.
IRA Distributions
Any distribution that you take from
tax deductible contributions or earnings that you do
not rollover or redeposit within sixty (60) days is taxable and must be
reported on your tax return. You are also subject to a 10%
penalty tax unless:
 | you are over age 59˝; |
 | you are totally disabled; |
 | you meet the exceptions below and pay medical costs; |
 | you receive unemployment compensation for at least 12 consecutive weeks and pay medical
insurance premiums with the distribution; |
 | you pay qualified higher education expenses with the distribution; |
 | the distribution is $10,000 or less and used for qualified first time home buyer
expenses; |
 | you are a beneficiary receiving the distribution following the death of the owner; or |
 | you receive annual payments under an annuity schedule. |
On or before April 1st of the
tax year after the tax year in which you reach age 70˝ you
must begin taking taxable distributions. A penalty tax of 50% applies to amounts that you were
required to take and didn't.
IRA Distributions - Medical expenses
There are penalty-free withdrawals from IRAs to pay for medical expenses that exceed
7.5% of adjusted gross income. You still have to pay regular income tax on this
money, however. Also, there are penalty-free withdrawals for unemployed people to pay for
health insurance.
IRA Distributions - Higher education expenses
The 10% penalty tax that applies to most withdrawals from IRAs before you reach age
59˝ will not apply to withdrawals for your higher education
expenses, or those of your spouse, children, or grandchildren. This change applies to
distributions after 1997 for expenses paid for academic periods after 1997.
IRA Distributions - First time home buyers
The law also permits a tax
penalty free qualified first-time homebuyer distribution,
subject to a $10,000 lifetime limit. The tax penalty free distribution must be used to acquire a principal
residence of the taxpayer, a spouse, child, grandchild, or ancestor.
IRAs are tricky, and there are
tax penalties if you contribute too much, receive too much,
or take out money too early.
|
 |
| Related tax
information about IRAs |
Tax Directory Topics:
Roth IRAs
SEP IRAs
SIMPLE IRAs
Keogh Plans
Are IRA rollovers
taxable on my tax return?
Adjustments to Income |
IRS publications about
IRAs:
For additional information, refer to Tax Topic
451, IRAs, or IRS Publication
590, Individual Retirement Arrangements (IRAs). For
further
education information refer to IRS Publication
970, Tax Benefits for Higher Education;
IRS Publication 508, Educational
Expenses; IRS Publication 1577,
Applying for Educational Financial Aid; and IRS Publication 520, Scholarships
and Fellowships. Also see IRS Publication
17, Your Federal Income Tax. Please
read this IMPORTANT
Editor's Note regarding navigating IRS Publications with
Adobe Acrobat Reader.
IRS publications can also be ordered by calling
1-800-829-3676. |
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