Individual Retirement Arrangements – Do you want savings for the future + less taxing?

Retirement is that phase of our lives when, though we incur lifestyle expenses, our income stream has either stopped or has trickled down. To meet the ever increasing expenses, a retirement corpus becomes a necessity. If you are employed, the chances are that your employer has made retirement provisions for you. If you are self-employed, you make your own retirement arrangements. In fact, even salaried employees make their own retirement arrangements? Why, you must wonder. Well, who doesn't like saving for their future and also save tax in the process?

Individual Retirement Arrangements (IRAs) are like retirement savings accounts. You can save money in IRAs and use the money to invest in various saving instruments. IRAs help in creating a retirement corpus while at the same time save taxes. Let us understand how IRAs work –

IRAs are of two types. One is the traditional IRA and the other is the Roth IRA.

  • Traditional IRAs – in case of traditional IRAs, the contributions you make are tax exempted. It means that you can claim tax exemption on the contribution made to traditional IRA. Later, when you withdraw from the account, the proceeds would be taxable. Thus, traditional IRAs help in deferring your taxes. You pay taxes not on your contributions but on your withdrawals.

  • Roth IRAs – Roth IRAs are completely opposite from traditional IRAs. In this instance, the contributions you make are included in your taxable income. Thus, you don't get any tax relief on your contributions. Withdrawals, on the other hand, are tax-free.
You can have both types of IRAs for retirement funding. However, the contribution to both or one account is limited in nature. For 2017, you can make a total contribution of $5500 to any one or both IRAs.

IRA contributions and taxes

Contributions to Roth IRA are a part of your taxable income. So, you cannot claim tax deduction on them. In case of traditional IRAs though, you can claim deduction from your taxable income on your contributions. However, the amount of tax deduction available on your contributions depends on whether you or your spouse has an employer-sponsored retirement plan and the following factors:

  • Your filing status
  • Your Modified Adjusted Gross Income (MAGI)
Let's see how:

If you or your spouse are covered by an employer sponsored retirement plan –

Filing Status MAGI
Single or Head of Household Less than $62,000 – up to $5500
Higher than $62,000 but lower than $72,000 – partial deduction
$72,000 and above – no deduction
Married filing jointly or qualifying widow(er) Less than $99,000 – up to $5500
More than $99,000 but less than $119,000 – partial deduction
$119,000 and above – no deduction
Married filing separately Less than $10,000 – a partial deduction
$10,000 and above – no deduction

If you are not covered by an employer sponsored retirement plan –

Filing Status MAGI
Single, Head of Household or qualifying widow(er) Full deduction till the contribution limit of $5500 for any amount of MAGI
Married filing jointly or separately where the spouse is not covered by an employer sponsored retirement plan Full deduction till the contribution limit of $5500 for any amount of MAGI
Married filing jointly where the spouse is covered by an employer sponsored retirement plan Less than $186,000 - up to $5500
More than $186,000 but less than $196,000 – partial deduction
$196,000 and above – no deduction
Married filing separately where the spouse is covered by an employer sponsored retirement plan Less than $10,000 – a partial deduction
$10,000 and above – no deduction

IRAs help you create a retirement corpus and also provide tax reliefs either immediately (in case of traditional IRAs) or when you withdraw (in case of Roth IRAs). So, make the most use of IRAs to create savings for your future and also save you tax.