The Traditional IRA Tax Deduction: Benefits and Taxes of IRAs

Saving for retirement should be a priority for every working adult, regardless of age. In fact, the best time to start saving for future expenses is when you begin your career, whereby you enable years of contributions and interest to grow into your nest egg. Regardless of when you start saving for retirement, knowing which retirement plans offer the most benefits for you will be quite advantageous.

There are many plans and strategies available to individuals looking to save money toward retirement. With so many choices, determining which plan best meets your needs can be a bit overwhelming.

Let’s take a closer look at the traditional IRA and why this plan may offer the most tax advantages for your retirement savings needs:

What is an IRA?

An IRA is an individual retirement account that can be opened by any person who meets the eligibility requirements. IRAs are ideal for self-employed individuals who may not have access to an employer-sponsored retirement plan. Even those with access to other retirement plans may find the tax benefits associated with an IRA worthy of opening a separate retirement account. The two most-discussed IRA types are Traditional and Roth. Both are excellent tools to save for retirement, but each offers different tax advantages.

Tax Benefits of a Traditional IRA

When taxpayers file their annual income tax returns, most do so with the hopes of owing as little as possible to Uncle Sam. Tax liabilities are determined by taxable income. To reduce the amount of taxes owed, tax deductions and creditscan be used to lower the amount of income that is taxed. This is where the traditional IRA can save you money on taxes now while you are saving money for the future. When you contribute to a traditional IRA, the contribution amount for that tax year may be fully or partially tax-deductible. With no taxes paid on contributions in the year, they are made, taxpayers have an opportunity for tax-deferred growth in their retirement account. Once contributions are made to the account the transactions in the account (interest, dividends, and capital gains) are not subject to tax. This is favorable tax treatment for those individuals that plan to move funds around over the lifetime of their investment because gains will not be taxed when an investment is sold.

2011 Traditional IRA Contribution/Deduction Limits

The IRS typically will update maximum contributions limits on an annual basis to adjust for inflation. There is only a limited amount an individual can reduce their taxable income by through traditional IRA contributions. Below are the contribution limits for 2011 contributions:

• Under 50: The smaller of $5,000 or the amount of your taxable income for 2011
• Over 50: The smaller of $6,000 or the amount of your taxable income for 2011

Why Choose a Traditional IRA Over Other Plans?

Choosing the best retirement plan for your financial goals is something that each person must do based on his own unique situation. The traditional IRA is ideal for taxpayers who anticipate being in a lower tax bracket in retirement, which is when distributions from the account may begin and will be taxed. The immediate tax benefit holds plenty of appeal for those in need of tax relief now versus later. As with all savings plans, it is important for the account owner to understand both the benefits and the drawbacks of that account before making a final decision.

In the case of traditional IRAs, the tax benefits in the present are obvious; however, it should be noted that distributions from the account will be subject to taxation at the current tax rate. When considering a traditional IRA, keep in mind any other retirement accounts that you are already contributing to, as other plans may affect the deductible amount allowed as well as the amount of contributions permitted each tax year. The restrictions on income and threshold for contributions may change from year to year; therefore, you must be sure that you are within the guidelines to obtain the maximum benefit without being penalized.

If you are unsure or have any questions as to whether or not a traditional IRA is something that might benefit you, it is always a good idea to seek the advice of a tax professional or a financial advisor.