IRA Types

• The IRS allows you deduct money you put into a traditional IRA, up to an annual limit, from your taxable income. Because Uncle Sam does not generate income tax from these contributions, you always pay regular income tax when you withdraw traditional IRA money, regardless of the timing. Roth IRAs work in the inverse. While you cannot deduct contributions, the IRS exempts original contributions from taxes no matter when you access them.
  
  

Function

• When you take your traditional IRA tax deduction it does not lower your tax due dollar for dollar. If it did, the IRS would classify it as a tax credit, not a deduction. Instead, the amount is deducted from your taxable income. Consequently, the value of the deduction will depend on your tax bracket.
  
  

Example

• Consider that your total income reported on your only W2-form in a given year was $50,000. Your deductions for things like mortgage interest, allowable business expenses, etc., amounted to $6,000 that you would subtract from that figure, bringing your adjusted gross income down to $44,000. At this juncture, the IRS bases your federal tax bracket -- and tax due -- on this number. If you contributed $2,000 to a traditional IRA, you could reduce your adjusted gross income to $42,000, further reducing your resulting tax due.
  
  

Limits

• The IRS places overall limits on how much money you can contribute to all of your IRAs in a given year. As of January 2011, you can put no more than $5,000 a year into your IRAs. The IRS raises the limit to $6,000 for individuals 50 years of age and older. The IRS may reduce or eliminate your ability to deduct traditional IRA contributions on the basis of several factors, mainly your income and whether or not a workplace retirement plan covers you or your spouse. For instance, if you are covered by a workplace plan, you use the single filing status and you make $55,000 or less, you can take a full deduction, as of January 2011. If your income exceeds $55,000, the IRS begins reducing the amount you can deduct. Once you hit $65,000 or higher, the IRS eliminates your traditional IRA deduction completely. Refer to IRS Publication 590 for details regarding your specific situation.
  
  

Timing

• When you make a deductible contribution to your traditional IRA, the IRS allows you to designate the tax year you want it to apply to. You have up until the filing deadline for your personal income taxes (usually April 15) to make a contribution for the previous year. For example, if you did not make an IRA contribution for the year 2010, you can make a contribution in 2011 and apply it to 2010 as long as you do it before the tax filing deadline.