How Much Will an IRA Reduce My Taxes?

Individual Retirement Accounts (IRAs) offer a strategic way to save for retirement while reducing taxable income. Understanding the tax implications of an IRA can significantly impact your financial planning and savings.

This article explores how contributing to an IRA might lower your taxes, focusing on deductible contributions, adjusted gross income, and phase-out ranges.

Deductible Contributions

Contributions to a traditional IRA can reduce taxable income. For the 2024 tax year, individuals under 50 can contribute up to $6,500, while those 50 and older can contribute $7,500 due to the catch-up provision. The deductibility of these contributions depends on income and whether you participate in an employer-sponsored retirement plan.

If you are not covered by a workplace retirement plan, the full contribution is typically deductible regardless of income. However, if you or your spouse has access to one, deductibility is subject to income limits. For 2024, singles or heads of household begin losing the deduction at an adjusted gross income (AGI) of $73,000, with it fully phasing out at $83,000. For married couples filing jointly, the phase-out range is $116,000 to $136,000 if the contributing spouse is covered by a workplace plan.

If your income nears these thresholds, strategies like deferring income or accelerating deductions can help you qualify for the full deduction. Consulting a tax professional can ensure compliance with IRS rules and maximize your tax benefits.

Adjusted Gross Income

Adjusted Gross Income (AGI) determines eligibility for many tax deductions and credits, including those related to IRA contributions. AGI is calculated by subtracting specific deductions, such as student loan interest and alimony, from total gross income.

A lower AGI increases the chances of qualifying for a full IRA deduction and may make you eligible for other tax benefits, such as the Saver’s Credit, which rewards low- to moderate-income individuals contributing to retirement accounts.

Managing AGI requires strategic planning. Options include increasing contributions to employer-sponsored retirement plans to reduce taxable income and timing income or deductions to maintain a favorable AGI. For example, deferring bonuses or accelerating deductible expenses can help lower AGI and maximize tax savings.

Phase-Out Ranges

Phase-out ranges gradually reduce the deductibility of IRA contributions as income rises, focusing tax benefits on moderate-income earners.

As income nears the upper limit of the phase-out range, the deductible amount decreases. Proactive financial planning is essential, especially if income fluctuates or is expected to increase. For example, maximizing IRA contributions earlier in the year when income is lower can secure a larger deduction.

Phase-out ranges also interact with other income-based tax benefits, such as the Child Tax Credit or education credits. Keeping a comprehensive view of your financial situation allows you to strategically manage taxable income, ensuring you remain eligible for key tax benefits.

Calculating Tax Savings

Tax savings from IRA contributions depend on how they reduce taxable income and overall tax liability. Your marginal tax rate determines the amount saved on each dollar contributed. For example, in the 24% federal tax bracket, each dollar contributed reduces tax liability by 24 cents.

State income taxes can add to these savings. States that mirror federal treatment of IRA contributions provide additional tax benefits. For instance, in a state with a 5% income tax rate, a $6,500 contribution yields combined federal and state savings.

Reducing taxable income through IRA contributions can also enhance eligibility for other tax breaks, such as the Earned Income Tax Credit, further increasing savings. Taking a holistic approach to financial planning ensures you maximize all potential tax benefits.