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Do IRA contributions reduce AGI? Yes, they surely can. Contributions to a traditional IRA are made with pre-tax dollars and do reduce your AGI. However, contributions to a Roth IRA do not lower adjusted gross income.

Your AGI is how much you have earned in a tax year after taking any applicable deductions. Of all of the line items on a tax return, this is among the most important because it directly relates to the amount you pay in taxes. Many people will attempt to reduce their adjusted gross income because of the direct connection between your AGI and your tax liability.

One of the most common questions we are asked is whether or not IRA contributions are a way of lowering adjusted gross income.

Yes!

But not always.

Let’s see how and why.

Do IRA Contributions Reduce AGI?

You can make contributions into an IRA with pre or post-tax dollars. If you elect to use pre-tax dollars, as with a traditional IRA, you reduce your AGI by deferring taxes on the income until withdrawal. At that point, the money will be included in your taxable income. 

You must have earned income to contribute to an IRA. If you are enrolled in a retirement plan through your work, you may not be able to deduct IRA contributions if you make above $76,000 as a single filer or $125,000 married filing jointly. There is no income limit to making a nondeductible traditional IRA contribution.

If you are not working but your spouse does, you may be able to contribute to your IRA if your total modified adjusted gross income is within the IRS limits. 

Do Roth IRA Contributions Reduce Taxable Income?

A Roth IRA is funded with post-tax dollars. Therefore, it does not reduce your AGI. Investments grow tax free and there are no taxes on qualified withdrawals. This is ideal for individuals who are in a lower tax bracket now than they expect to be at the time they withdraw their funds, such as those early in their career.

Traditional IRA vs. Roth IRA

A traditional individual retirement account (IRA) is funded with pre-tax dollars. Taxes are paid at the time of withdrawal. Roth IRAs are funded with after-tax money. Funds grow tax free and qualifying withdrawals are not taxed. This is ideal if you are presently in a lower tax bracket, like when you are early in your career.

What’s The Difference?

Traditional IRA contributions are made with pre-tax dollars. Therefore, they do reduce your AGI. However, you will pay taxes when you withdraw the funds at retirement.

Roth IRA contributions are not tax-deductible, and therefore do not reduce your AGI. However, there are no taxes on withdrawals in retirement (i.e. after your turn 59 ½).

Pros and cons of Traditional IRA

There are several benefits to the traditional IRA. As with all financial products and investment vehicles, though, it isn’t without limitations and drawbacks, too.

Pros:

  • Reduced AGI and, therefore, tax liability
  • Deductible contributions
  • Growth is tax-deferred
  • Available in addition to existing employer-sponsored plans

Cons:

  • Hefty early withdrawal tax and penalties of 10% before age 59 1/2
  • Lower contribution limits than 401k
  • Undeterminable tax rate as you are taxed at your tax rate at the time of withdrawal
  • Required minimum distributions beginning at 72

Pros and cons of Roth IRA

Let’s also review the pros and cons of the Roth IRA.

Pros:

  • Tax-free growth of your investments
  • You can withdraw your contributions at any time without being penalized
  • You do not need to take required minimum distributions at any time
  • Withdrawals are not subject to taxes or penalties, if they are qualified
  • Contributions to Roth IRAs may be withdrawn anytime without penalty; taxes and penalties are only assessed before age 59 1/2 on withdrawn earnings

Cons:

  • Taxes are paid upfront
  • Contributions do not lower your AGI
  • Roth IRA’s have income limits; you cannot open a Roth if you earn over $140,000 as a single filer or $208,000 if married filing jointly
  • Are Roth IRA contributions tax deductible? Not generally.

2021 IRA Contribution Limits

In 2021, the contribution limit is $6,000 per year unless your income is below $6,000. In that case, you cannot contribute more than you earn. Individuals age 50 or older are eligible for catch-up contributions which raises the contribution limit to $7,000 per year.

Additional Ways to Lower AGI

Contributions to a traditional IRA are one way to reduce your AGI. It isn’t the only way, though! Let’s take a look at some short-term and long-term opportunities to reduce your AGI. Even more in-depth approaches can be found on our guide to high-earner tax reduction strategies.

Short-term Strategies to Reduce AGI

Tax Loss Harvesting

The idea behind tax loss harvesting is simple: sell investments at a loss to offset your gains on other investments.

When you have stocks that you are ready to sell, even though it is at a loss, this will reduce your net profit. As a result, you effectively reduce your tax liability.

Charitable Donations

Donating funds to a charitable organization provides an opportunity to reduce your taxable income.

There are limitations on what can and cannot be deducted for taxes. For example, you cannot deduct the value of the time you donate to a charity.

To maximize your deduction, be sure to itemize deductions if they exceed the standard deduction. If you do not, your charitable contributions surely won’t be in vain, but they may not result in any tax savings at all. A strategy to consider if you’re over the age of 72 is called a qualified charitable distribution or QCD.

Long-Term Strategies to Reduce AGI

Health Savings Accounts

Putting money into an HSA can help you save for future medical expenses when they happen. These are funded with pre-tax dollars, so they can help lower your taxable income.

Want to know another way to leverage an HSA?

Don’t withdraw from it.

<p>You don’t need to request reimbursement from your HSA at the time of the medical expense. You can be reimbursed anytime. By deferring your reimbursement, you allow your contributions to grow tax-free. </p>

Hire your Child

If you own a business, especially one with pass-through income like an LLC, hiring your child is a fantastic way to reduce your AGI while setting your child up for success.

Make sure your child is providing a legitimate service, but you can get creative with this. The work they can do will depend on the business you operate. However, even young children can provide valuable contributions to a company by handling mail, filing paperwork, acting as a model for marketing material, or more.

Are you ready for the exciting part?

If your child is earning income, they are eligible to make contributions to a Roth IRA. Since their earnings will likely be low compared to their future earnings, they will pay very little tax and have a spectacular opportunity to begin saving for retirement early.

Summing it up

Do IRA contributions reduce your AGI?

Yes! Contributions to a traditional IRA are made with pre-tax dollars and do reduce your AGI. However, contributions to a Roth IRA do not reduce AGI.

Do Roth IRA Contributions Reduce Taxable Income?

Roth IRA contributions are made with post-tax dollars and do not reduce your taxable income.

Are Roth IRA Contributions Tax Deductible?

Not generally. However, low and moderate earners who qualify for the Savers Credit may be eligible for a tax credit of 10-50% of their Roth IRA contributions.

Contributions to a traditional IRA are one way to reduce your AGI. It isn’t the only way, though!

There are plenty of smart strategies you can employ when it comes time for filing taxes. Take advantage of these short and long-term approaches to keep more money in your pocket year after year.

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Dechtman Wealth Management, LLC [“DWM”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from DWM. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. DWM is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the DWM’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request or at www.dechtmanwealth.com.

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