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How can I get to know about retirement IRA contribution deduction
Tax-deductible IRA contributions
Curious about using your retirement contribution to get a tax deduction? Well, you’re in the right place. Self-employed individuals can deduct their IRA (Individual Retirement Account) contributions as a tax deduction.
However, only traditional IRA contributions can be deducted. And the amount that is deductible is dependent on your filing status, whether you are already part of another retirement plan that is sponsored by an employer and your Modified Adjusted Gross Income (MAGI).
Key takeaways:
- IRA contributions is a valid tax deduction for self-employed individuals
- The deductible IRA amount is dependent on factors like income limits, filing status, and whether you or your spouse already contribute to a retirement plan
- Only traditional IRAs are tax-deductible
Table of contents
What is a traditional IRA?
Anyone can open a traditional IRA account. This type of retirement plan is tax-deductible, meaning you can claim this deduction when you file your taxes. However, there are certain rules around claiming a traditional IRA deduction.
The full deduction of your IRA contribution can only be claimed if neither you nor your spouse are covered by any additional retirement scheme. The contribution limit for an IRA stands at $6,000 annually, but if you are 50 years or older, you can add another $1,000.
If you or your spouse are covered by another retirement plan, things get a little more complicated. If you already have a retirement plan paid for by an employer like a 401(k), you can only deduct a certain amount that is dependent upon your 2022 filing status and income limit.
If you are over any of the income limits, you are still allowed to make a contribution to your IRA. You just can’t claim the contribution as a tax deduction.
Quick tip
Use a self-employment income tax calculator to make finding tax deductions a lot easier.
How to claim the traditional IRA contribution tax deduction
Tax-deductible traditional IRA contributions should be reported on Schedule 1 (part of Form 1040). "Remember that this deduction is not directly related to self-employment taxes but does help in lowering taxable income.
Having a lower taxable income can be beneficial for estimated quarterly taxes. You can use a estimated tax calculator to check whether you will need to make this payment to the IRS. If you happened to forget or just weren’t able to make the April deadline, a tax penalty calculator can help.
Are there retirement plans specifically for the self-employed?
If you’re a small business owner with a few employees or a self-employed individual operating solo, you can opt for a Simplified Employee Pension (SEP) plan. This plan has a high contribution limit and is a good option if you’re newly self-employed. $61,000 or 25% of your net income is the contribution limit for 2022. And because this is a traditional IRA, the contribution is tax-deductible.
Another option is a solo 401(k) plan. As the name suggests, this retirement plan is only for individuals. The contribution limit requires a little bit of calculation as you are acting as both the employer and the employee.
The IRS has a separate page that shows you how to do this. In terms of claiming a tax deduction, you can deduct the portion you contribute as an employer when you file. You can also claim the account maintenance fees as a tax deduction.
A defined benefit plan is a less popular option but is still useful for self-employed individuals with higher income who are looking to save large amounts for their retirement. But you will need a third-party actuary to determine your contribution limit, which may add an extra step to your process.
The last plan we’ll talk about is the Savings Incentive Match Plan for Employees (SIMPLE). This is another traditional IRA that is usually chosen by small business owners with less than 100 employees.
You can contribute up to $15,500 (plus $3,500 if you’re 50 or older) in 2023 as an employee, with your employer contributing either 3% of your salary or a fixed 2% every year. And like a traditional IRA, both the employer and the employee can claim the tax deduction.
As you can probably tell, choosing the right retirement plan requires a lot of planning and research. Keeping track of your contributions and correctly reporting them as tax deductions can be confusing.
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