Typically when I file taxes, I begin to think about all the things in the prior year I could’ve done to save more money on how much I owe. This often comes back to expenses I could’ve tracked better to use as tax deductions. Tax deductions allow you to decrease your taxable income, saving you money on taxes.
One of the more common ways to get a tax deduction is by using a retirement account. A 401(k) plan is the most popular type of retirement account, mainly because it’s offered through employers. Of working-age people in the U.S., over 34% have a 401(k)-style plan — a 403(b) and 503(b) count.
Many fewer people use an individual retirement account (IRA) — just over 18%. Yet IRAs have many benefits you don’t receive with a 401(k) plan. One type of IRA, a traditional IRA, can be a great tool to prepare financially for retirement. It’s a two-for-one for investors.
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More investing freedom than a 401(k)
Like a 401(k), a traditional IRA allows you to deduct your contributions from your taxable income, but there are some clear differences between the two. To begin, a traditional IRA isn’t offered through an employer and must be opened on your own, similar to a brokerage account.
The other clear difference is that 401(k) investment options are provided to you. With a traditional IRA, you can invest in any stock or exchange-traded fund (ETF) that you can in a brokerage account. This gives you more freedom to tailor your investments to match your financial goals and risk tolerance.
IRAs have much lower annual contribution limits than 401(k)s — $6,500 ($7,500 if you’re 50 or older) for tax year 2023. So you might not want to use them as your primary retirement account, but they can be a great resource nonetheless.
How traditional IRA deductions work
While anyone can contribute to a traditional IRA, not everyone is eligible to deduct their contributions. Whether you’re allowed to make a deduction (and how much) depends on your tax filing status, income, and if you’re covered by a retirement plan at work.
Here’s how much of your traditional IRA contributions you can deduct for the 2023 tax year if you are covered by a retirement plan at work:
| TAX FILING STATUS | INCOME | DEDUCTION ALLOWED |
|---|---|---|
| Single | $73,000 or less | Full amount |
| Single | $73,001 to $82,999 | Partial amount |
| Single | $83,000 or more | No deduction allowed |
| Married, filing jointly | $116,000 or less | Full amount |
| Married, filing jointly | $116,001 to $135,999 | Partial amount |
| Married, filing jointly | $136,000 or more | No deduction allowed |
| Married, filing separately | Less than $10,000 | Partial amount |
| Married, filing separately | $10,000 or more | No deduction allowed |
Data source: Internal Revenue Service
Here’s how much of your traditional IRA contributions you can deduct for the 2023 tax year if you are not covered by a retirement plan at work:
| TAX FILING STATUS | INCOME | DEDUCTION ALLOWED |
|---|---|---|
| Single | Any amount | Full amount |
| Married, filing jointly or separately (with a spouse not covered by a work plan) | Any amount | Full amount |
| Married, filing jointly (with a spouse who is covered by a work plan) | $218,000 or less | Full amount |
| Married, filing jointly (with a spouse who is covered by a work plan) | $218,001 to $227,999 | Partial amount |
| Married, filing jointly (with a spouse who is covered by a work plan) | $228,000 or more | No deduction allowed |
| Married, filing separately (with a spouse who is covered by a work plan) | Less than $10,000 | Partial amount |
| Married, filing separately (with a spouse who is covered by a work plan) | $10,000 or more | No deduction allowed |
Data source: Internal Revenue Service
Depending on your tax bracket, being able to deduct up to $6,500 or $7,500 from your taxable income could save you thousands in taxes.
When it makes sense to use a traditional IRA
Choosing between a traditional and Roth IRA comes down to one thing: When you pay taxes. For eligible people who expect their income to be higher in retirement, it makes sense to go with a Roth IRA, so you can pay taxes now instead of later when you may be in a higher tax bracket.
If you’re in your peak earning years and your tax bracket in retirement will be lower, it typically makes sense to go with a traditional IRA, so you can take the tax deduction now and then pay taxes on withdrawals in retirement when you’re in a lower tax bracket.
Saving and investing for retirement is great. Saving and investing for retirement while getting a tax break is even better.
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