The Tax Reality of IRA Contributions

When you’re first starting out in the working world, taxes can be a tad unpredictable. Those years spent at University where you were magically issued a big check from the government are over and you have to manage your new income differently. This is especially true once you decide that you want to start investing, as you are introduced to a whole slew of financial restrictions and rules.

For instance, there are many different variables to consider when it comes to investing in an IRA. IRAs can be smart, valuable additions to your portfolio, but its important to make sure to know the rules around what your investing in. When it comes to taxes, IRAs are governed by different sets of rules that have advantages and pitfalls depending on your personal financial situation and what tax bracket you operate in.

IRA, or traditional investment accounts, contain money that you don’t see for decades to come. So it’s important to know exactly what the taxation rules are around that money, as you don’t want to be patiently awaiting a withdrawal only to find out that the actual money you receive is much less than you had planned for. Surprises are nice for birthdays or anniversaries. Surprises in long term investments, which are built to be stable? Usually not a great thing.

Traditional IRAs have limits on deductibles, so when you make a contribution to the account, while you are able to claim a deductible, you can’t claim all the investments in into the IRA that you make. You are able to figure out how much you can deduct by measuring your filing status along with your gross income. Once you make those calculations, you’re able to determine how you are permitted to deduct.

Since 2014, the rules around deductibles have meant that if you are under 49 and a half years old, you’re able to deduct $5,000 of net income for tax purposes. Those older than 50 are able to claim $6,500. As well, money contributed to a retirement fund will still be allocated as income for tax reasons. Other than what you’re putting into the IRA, you won’t feel too much of a tax squeeze while putting funds into your account. Later on, though, you will feel a bit of a crunch, as you are taxed on what you withdraw from the IRA.

At this time, the non-taxable funds you put in long ago are now, unfortunately, taxable. There is an exception, however, as you aren’t required to pay a lump amount on the cash in your retirement savings account. The only amount that is taxable is that which you withdraw.