While most people are interested in increasing their income, it may be prudent for a taxpayer to reduce it instead. A lower income obviously means you pay less in taxes, but it may also allow you to take advantage of other deductions and benefits that would not be available with the higher income. While an IRA itself cannot lower income, contributions to some IRAs may reduce taxable income for the year.
A traditional IRA account contribution is tax deductible for the contributor. Unlike other itemized tax deductions, such as mortgage interest, the traditional IRA is an above-the-line deduction. The amount of the contribution is subtracted from the taxpayer's gross income, to return a figure called the adjusted gross income (AGI.)
A Roth IRA delivers no immediate tax benefit because it is not deductible from income either above the line or as an itemized deduction. In exchange for forgoing the tax benefits at the present time, a Roth IRA has significant tax benefits for the future. All withdrawals from a Roth IRA are tax free when the account owner is at retirement age, which is 59-1/2 as of publication.
Lowering your AGI has benefits other than reducing taxes. Many tax benefits and deductions are dependent on the AGI of the taxpayer, and these benefits are reduced, or eliminated, as the AGI increases. For example, medical expenses that exceed 7.5 percent of AGI are deductible as itemized deductions as of publication. If the AGI is lower, the minimum amount of expenses to claim a deduction also is lower.
Other Ways to Lower Adjusted Gross Income
Traditional IRA deductions are not the only above-the-line tax deductions that reduce AGI. Healthcare savings account deductions also reduce your AGI, as well as other deductible retirement contributions such as SEP or SIMPLE IRAs. Self-employment health insurance is also an above-the-line deduction. Contributing to a 401k also reduces your AGI, but not through tax deductions. 401k contributions are subtracted from your income on the form W2 for the year. Basically, 401k contributions are never reported as income