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This article was fact-checked by our editors and reviewed by CPA candidate Janet Murphy, senior product specialist with Credit Karma Tax®. It has been updated for the 2020 tax year.
It can be all too easy to put off getting your financial ducks in a row for retirement, especially if you’ve just started on your career path and retirement is decades away.
But saving in an individual retirement account can give you some tax benefit while you’re building a nest egg for the future. You can put money into an IRA even if you’re already participating in an employer-sponsored 401(k) retirement plan. And you may be able to deduct the IRA contributions from your taxable income, which can reduce your overall income tax bill.
The government limits how much you can invest in these tax-advantaged IRAs each year. But the good news is that you have until April 15, 2021, to contribute for the 2020 tax year and maximize your annual tax break as well as your future savings.
- What is an IRA?
- When is the IRA contribution deadline for 2020?
- Who can open a traditional IRA?
- What are the tax benefits of a traditional IRA?
- What are traditional IRA contribution and deduction limits?
What is an IRA?
An IRA — also known as an individual retirement arrangement — is a kind of savings account that offers tax benefits as an incentive to help you save for retirement. The money you contribute may be partially or entirely tax deductible, depending on your situation, and you don’t pay tax on the interest earned while the money is in your account. You only pay tax when you withdraw money from your IRA, assuming it’s a traditional IRA (more on that in a moment).
You can open the account on your own through a stockbroker, bank or other financial institution. You have the option of managing the account’s funds on your own, choosing which stocks, bonds and mutual funds to invest in. If you wish to withdraw the accumulated funds without incurring a penalty, you have to meet certain requirements.
There are four major types of IRAs that you can deposit pretax or after-tax dollars into.
- Traditional IRA — This type of account allows you to make tax-deductible deposits and tax-deferred investments. You only pay tax on the money when you withdraw it in retirement.
- Roth IRA — With a Roth IRA, contributions aren’t tax-deductible. But qualified distributions from a Roth IRA are tax-free, so you won’t pay any tax on the money in retirement. There are also other differences between traditional and Roth IRAs.
- Simple IRA — A savings incentive match plan for employees allows both employees and employers to contribute to employer-sponsored IRAs set up for employees. Small businesses with fewer than 100 employees typically use this IRA.
- SEP IRA — A simplified employee pension plan allows businesses and self-employed people to contribute up to 25% of an employee’s pay to an individual retirement account set up for each employee. Only an employer can contribute to an employee’s SEP IRA.
For the purposes of this article, let’s focus on traditional IRAs, how they work and the extended deadline for making contributions that will count toward your 2020 taxes.
When is the IRA contribution deadline for 2021?
The deadline to contribute to an IRA is normally the same as the deadline to file your tax return: April 15. Because of the coronavirus pandemic, the federal government extended the tax filing and payment deadline for 2019 taxes to July 15, 2020, which gave everyone 90 extra days to make IRA contributions.
If you haven’t yet maxed out your IRA contribution for 2020 (more on contribution limits later), you have some time to put money away. Many brokers, banks and other financial institutions will allow you to make contributions online.
Who can open a traditional IRA?
You can open a traditional IRA if you or your spouse (if you file a joint return) received taxable income during the year, such as wages or income from work, and if you are younger than 70½ by the end of the tax year.
If you’re married and you and your spouse both fulfill these conditions, you each can open separate accounts, not a joint IRA. Employed spouses can also contribute to the IRA of their nonworking spouses, with limitations.
You can open an IRA at a bank, brokerage firm, insurance company or other financial institution. Many companies also allow employees who enroll in a retirement plan to designate how much they’ll contribute to a traditional IRA via a payroll deduction.
What are the tax benefits of a traditional IRA?
Nearly two-thirds of 40-year-old Americans have less than $100,000 in retirement savings, according to a January 2020 TD Ameritrade poll. And 20% of people in their 70s have less than $50,000 in retirement savings.
So it’s important to save as much as you can, especially when you have a tax-advantaged way of doing it through IRAs.
With a traditional IRA, you may be able to deduct qualified contributions to reduce your taxable income. You also benefit from tax-deferred growth of your investments in an IRA account: Your contributions — and earnings on these contributions — aren’t taxed until you withdraw them.
The amount of income tax you’ll pay when you withdraw the money will depend on your tax bracket and age at the time of withdrawal. Generally, if you withdraw money from your traditional IRA before you’re 59½, you’ll pay an additional 10% tax. If you wait until you retire to begin making withdrawals from your traditional IRA, your investments and other sources of income (such as Social Security or income from a rental property) may be less than when you were working, and you could be in a lower tax bracket than you were during your working years. This could help you save taxes on your retirement income and keep more of your savings.
What are traditional IRA contribution and deduction limits?
The IRS sets contribution and deduction limits for IRAs every year. The contribution limit determines the total dollar amount you can put into your retirement account during the year, while the deduction limit determines the portion of this money that you can deduct to reduce your taxable income.
Contribution limits for traditional IRAs
For 2020, you can contribute a total of up to $6,000 to all your IRAs — both traditional and Roth if you have them — if you’re younger than 50. If you’re 50 or older, you can make a catch-up contribution of an additional $1,000, bringing your annual contribution limit to $7,000. But you can’t contribute to a traditional IRA for 2019 if you’re 70½ or older.
There is no age limit for IRA contributions as of the 2020 tax year. The Setting Every Community Up for Retirement Act of 2019 eliminated the age limit for traditional IRA contributions.
Deduction limits for traditional IRAs
The deduction amount you can take depends on your modified adjusted gross income, or MAGI, as well as your filing status and whether you or your spouse are covered by a workplace retirement plan such as a 401(k). Income phaseouts apply.
If you’re covered by a retirement plan at work, here’s what you can deduct — or not deduct — for the 2020 tax year.
|Filing status||Full deduction up to contribution limit based on MAGI limits of …||Partial deduction based on MAGI limits of …||No deduction if your MAGI is …|
Single or head of household
$65,000 or less
More than $65,000 but less than $75,000
$75,000 or more
Married filing jointly or qualifying widow(er)
$104,000 or less
More than $104,000 but less than $124,000
$124,000 or more
Married filing separately
Less than $10,000
$10,000 or more
If neither you nor your spouse participated in a workplace retirement plan — such as a 401(k) — you can deduct the full amount of your contributions.
Just make sure you don’t exceed your IRA contribution limit for the year. If you exceed your contribution limit, the IRS will impose a 6% tax each year on the excess above $6,000 that you put into your IRA, or $7,000 if you’re 50 or older. For example, if your contribution limit is $6,000, it may be in your best interest to stick to this number or to withdraw any excess contributions before the tax filing deadline so you can avoid this penalty.
If you exceeded your contribution limit, you must report it on Form 5329 and file it along with your annual tax return. And if you aren’t able to deduct any portion of the amount you contributed to a traditional IRA, you need to file Form 8606.
IRAs help you grow your retirement nest egg, boosting your savings to give you a chance to enjoy the same — or close to the same — quality of life in your golden years as you have during your working years.
Unfortunately, many Americans don’t take full advantage of these tax-advantaged accounts. If you haven’t yet funded your traditional and Roth IRAs to the contribution limit, consider using the next few months to make sure you hit your contribution limit by the extended April 15 deadline.
IRS: Retirement Topics – IRA Contribution Limits | IRS: Individual Retirement Arrangements | IRS: IRA Deduction Limits | IRS: 2020 Contribution and Deduction Limits Effect of Modified AGI on Deductible Contributions if you are Covered by a Retirement Plan at Work | IRS: Traditional IRAs | IRS: Individual Retirement Arrangements: Getting Started | IRS Publication 590-A: Contributions to Individual Retirement Arrangements (IRAs) | IRS: Choosing a Retirement Plan – SEP | IRS: IRA FAQs – Contributions | IRS: Payroll Deduction IRA | IRS: IRA Year-End Reminders
A senior product specialist with Credit Karma Tax®, Janet Murphy is a CPA candidate with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.