What is a deductible contribution?
A deductible contribution is a payment to a traditional individual retirement account (IRA) that is tax deductible if you are not a beneficiary of your employer’s retirement plan.
A deductible contribution is the part of your retirement contribution on which you are required to pay a tax. Depending on your filing and income status, you may still deduct the payments to a traditional IRA even though you participate in a 401(k) or company pension plan. The exception to this is when you make a payment to a Roth IRA.
You can claim a deduction for the total contribution to your IRA on your individual national income tax. By allowing you to deduct your payments on your tax return, a deductible contribution can lower your tax bill; thus, you obtain a refund on your earlier paid taxes for that year.
Though a deductible contribution is a better deal, your qualification for one depends on your filing status, income, eligibility for Social Security benefits and access to a retirement plan sponsored by the employees at work.
You can make your contributions to traditional IRAs no later than the first date due for a tax return. Moreover, you can choose to contribute to a Roth IRA or traditional IRA, or both. Your total payment to either Roth or traditional IRAs for the year cannot be more than the annual maximum amount or the least year’s income.
You must pay taxes on the entire amount when you withdraw from your traditional IRA unless your traditional IRA includes nondeductible contributions. The percentage of the withdrawal that is equal to the nondeductible contribution rate is not taxed when withdrawing from a traditional IRA that includes nondeductible contributions.
Deductible contribution example
Sammy’s salary is $80,000, and he contributes $800 — equivalent to 1 percent of his compensation to his employer’s IRA plan. This $800 becomes Sammy’s deductible contribution.
Based on the requirements of the deductible contribution, the employer must balance the $800 contribution since he is required only to match the amount Sammy actually contributes up to 3 percent during the year that is the maximum of the year’s compensation.
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