One of the most important advantages of contributing to a traditional IRA is the tax savings that are available. There are three primary tax advantages of contributing to an IRA:

• Tax Deductions
• Tax Deferred Earnings Growth
• Retirement Savings Contributions Credit

Contributions to a Roth IRA are not tax deductible. However, you may be eligible for the Retirement Savings Contributions Credit as discussed below.

Contributions to a traditional IRA are usually tax deductible up to $4000 or the amount you contributed, whichever is less. If you are 50 or older, your maximum tax deduction is $5000.

The IRA deduction lowers your taxable income for the year in which you made contributions. As a result, your tax liability will be less. In fact, the deduction may also lower your tax bracket which results in even less tax liability.

For instance, suppose your reportable income is a total of $34,000, you file single using form 1040, you contributed $4000 to a traditional IRA, and you did not participate in a retirement plan at work.

In this scenario, you are eligible to deduct the full amount of your contribution which lowers your income from $34,000 to $30,000. This is now your adjusted gross income. Before going any further, let's interpret the tax savings from this IRA deduction.

According to the 2007 tax tables, the amount of tax owed on $34,000 is $5064. The amount of tax owed on $30,000 is $4301. That is a tax savings of $763. But we're not finished just yet.

HINT: If you participate in a 401(k) at work, your tax deductible amount may be lower based on your adjusted gross income and filing status.


Tax Deferred Earnings Growth.

Investments in a traditional IRA grow tax deferred. This means you do not have to pay tax on earned interest, dividends, and capital gains today. Instead, you will pay ordinary tax in the future when you receive retirement distributions. Again, this is a tax savings today by keeping your Total Income in check.

You may be eligible for a tax credit for up to 50% of your IRA contribution, with a maximum credit of $2000. The amount of your tax credit depends upon your income and filing status.

Note: This is a non-refundable tax credit, which means you will not receive a refund directly from this credit. Rather, this is a tax credit which reduces the total tax owed dollar for dollar.

The maximum credit is $1000 for single filers, and $2000 for married couples. The actual credit you are allowed is based on adjusted gross income and filing status. The lower your income the greater the tax credit you may receive.

Your 2007 Adjusted Gross Income cannot exceed the following amounts in
order to Qualify for Retirement Savings Tax Credit:

Filing Single, Married Separate, Widow: $26,000
Filing Married, Jointly: $52,000
Filing Head of Household: $39,000

In addition, you must use the 1040 or 1040a in order to qualify for the tax credit.

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