The idea behind a traditional IRA is that money goes in -- one hopes -- tax-deferred, and then grows tax-deferred until it is withdrawn in retirement. There's a 10% penalty plus taxes if you take money out before age 59 1/2, and you have to stop contributing and start taking withdrawals when you turn 70 1/2.
Until you reach that age, you can contribute to a traditional IRA, no matter what your income. Whether your contributions are tax-deductible, though, depends on two things: Whether you participate in a retirement plan at work and, if you do, your income level.
If you lack a retirement plan at work, there's no problem. Anything you contribute to your IRA, up to the $5,000 annual limit or $6,000 for anyone 50 and over, is tax deductible. Those limits, by the way, increase with inflation from time to time.
If you're covered by a retirement plan at work, you might still be able to make a tax-deductible IRA contribution. It all depends on your income, as defined by your modified adjusted gross income -- a number we will help you calculate a bit later on.
First, a look at the limits.
For people who participate in retirement plans at work, the deductibility of their IRA contribution begins to phase out at $56,000 for singles in 2010. (It was $53,000 in 2008 and $55,000 in 2009.) For joint-filers, the phase-out starts at $89,000 (It was $85,000 in 2008 and $89,000 in 2009.)
Deductibility disappears entirely for covered-at-work singles at $66,000 in 2010. (You were completed phased out with income of $63,000 in 2008 and $65,000 in 2009.) For joint -filers, your ability to deduct an IRA contribution disappears at $109,000. (It was $105,000 in 2008 and $109,000 in 2009.)
However, there is another "what if?" to be considered: What if you participate in a retirement plan at work, but your spouse doesn't have one?
You may be back in the tax-deductible ballgame. A non-covered spouse can make a tax-deductible contribution up to the full year's limit as long as the couple's joint income is below $167,000 in 2010.($159,000 in 2008 and $166,000 in 2009). The deductible amount phases out to zero, though, at $177,000 ($169,000 in 2008 and at $176,000 in 2009).
A spousal IRA contribution can be made even for a spouse who lacks enough income to cover the contribution. The rule is intended to benefit parents who don't work outside the home, and who might otherwise have no access to a personal retirement plan.
Coming up with a precise calculation for your modified adjusted gross income (MAGI) is a job best left to a tax professional, but here's a way to guesstimate it:
Start with your adjusted gross income, which is the bottom line of the first page of your tax return if you file a Form 1040 or 1040A. Add any raises in income to approximate your current year's AGI.
From there, add back any deductions you are taking for traditional IRA contributions, foreign housing allowances or income exclusions, savings bond interest, student loan interest and employer-paid adoption expenses.
After you've estimated your MAGI, an online calculator can help you determine whether you can make tax-deductible contributions to an IRA.