Question

Sheena makes a deductible traditional IRA contribution of $2000. Her tax rate in the year of the contribution is 28%. What is the reduction in Sheena’s tax liability (I.e., tax savings) as a result of the contribution? A. $0 B. $560

C. $1,440 D. $2,000

Answer 1

Ans: D. $2,000

Reduction in Sheena’s tax liability is 100% of traditional IRA contribution i.e; $2000.

Note:

Complete details of Sheena are not provided so we considerd sheena is unmarried and not participated in any retairment plan. So, the maximum contribution for 2018 is $5,500, but taxpayers who are 50 or older can contribute up to $6,500.

Traditional IRA Deduction Limits:
If Individual or spouse do not participate in a retirement plan at work, your traditional IRA contribution is fully deductible up to your contribution limit. The maximum contribution for 2018 is $5,500, but taxpayers who are 50 or older can contribute up to $6,500.

If Individual or spouse participate in an employer-sponsored retirement plan, such as a 401(k), tax deductions may be reduced or phased out entirely. The phase outs are based on income and filing status. These are the deduction phase outs for 2018:

If Individual is filing as single or head of household, the maximum tax deductible contribution phases out once modified adjust gross income (MAGI) - we’ll just call it “income” for simplicity’s sake - exceeds $63,000 and Individual become ineligible for a tax deduction when income reaches $73,000.
If person is married filing jointly and don’t participate in an employer-sponsored plan but your spouse does, the deduction is phased out once joint income exceeds $189,000 and become ineligible for a tax deduction when your income reaches $199,000.
If person is married filing jointly, participate in an employer-sponsored retirement plan and are the spouse making the contribution to the IRA, the deduction is phased out if your income is more than $101,000 but less than $121,000. Once income reaches $121,000, can’t deduct any of IRA contribution on tax return.
In other words, if income is below these levels, can make the maximum contribution and it will be fully deductible. If income is in between these levels ($63,000 to $73,000 for singles, for example), contribution will be partially deductible. If it is above these levels ($73,000 for singles), it is not tax deductible at all.

If married filing separately, the tax deduction limits are drastically lower. If participate in an employer-sponsored retirement plan and your income is less than $10,000, can take a partial deduction. Once hit $10,000, don’t get any deduction.

Individual can still contribute up to the annual maximum for the year to traditional IRA even if he can’t deduct all of it. Effectively, you’ll be making part of your contribution with after-tax dollars instead of pre-tax dollars if he max out his contribution despite facing a limited tax deduction based on his income.