There is a major retirement savings shortfall in America, with the vast majority of retirees not saving nearly enough to cover their expected income needs in retirement.

In an effort to help fix this problem, the IRS offers some rather generous tax advantages for retirement savers, and the deduction for traditional IRA contributions is an example that is available to most American workers. This could save the average single taxpayer $825 on their 2018 tax bill, and the average married couple could save double this amount, or $1,650. Many people could save even more.

Here's an overview of the traditional IRA deduction, and what it could mean to you in 2018.

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Contributing to an IRA in 2018

For the 2018 tax year, eligible individuals can contribute up to $5,500 to an IRA, or $6,500 if they're age 50 or older. This limit applies to both traditional and Roth IRAs, and is a per-person limit, meaning that if you have more than one IRA, your combined contributions cannot exceed the limit.

In order to be eligible to contribute to an IRA, you need earned income that is equal to or greater than your contribution. This includes wage income, as well as salaries, tips, bonuses, and income from a business that you actively participate in. Passive sources like dividends and interest income don't count. Roth IRA contributions are also restricted by income limitations.

Money that you contribute to an IRA can be invested in stocks, bonds, mutual funds, ETFs, and in cash equivalents like money market funds, and is allowed to grow on a tax-deferred basis. This means that you won't have to pay taxes each year on the dividends and capital gains generated by your investments.

The IRA tax deduction

If you contribute to a traditional IRA, you may be able to take a tax deduction for your contributions. We'll go over the eligibility requirements in the next section, but in a nutshell, most Americans can use their traditional IRA contributions to reduce their taxable income.

To further sweeten the deal, consider that the IRA tax deduction is what's known as an "above-the-line" tax deduction, which means that you can take it regardless of whether you itemize or not. Instead of simply reducing your taxable income like the standard deduction or itemized deductions can do, above-the-line deductions actually reduce your adjusted gross income, or AGI, which can in turn help you qualify for other income-based tax benefits.

It's worth pointing out that a traditional IRA is a tax-deferred type of investment account. This means that you get a tax break in the year you make your contributions, but your withdrawals will be considered taxable income.

If you contribute to a Roth IRA, you don't get a current-year tax break, but your qualifying withdrawals will be completely tax-free. And Roth IRAs have several other attractive benefits that savers may want to consider.

Income limitations

To be perfectly clear, all American workers are eligible to contribute to a traditional IRA, so long as they have earned income. However, the ability to take the traditional IRA tax deduction is limited by income for many people.

Specifically, if you do participate in an employer's plan, you can only take the traditional IRA deduction if your AGI is below certain limitations, which are set annually by the IRS. Here's a chart of the 2018 income limitations. (Note: In a previous article, you can find the 2017 traditional IRA deduction income limits.)

Data Source: IRS.

Here's how to interpret this chart. If your AGI falls below the full deduction limit for your corresponding tax filing status, you can take the full traditional IRA tax deduction, up to $5,500 or $6,500, depending on your age. If your AGI is greater than the full deduction limit, but less than the phase-out limit, you are eligible for a partial deduction which you can calculate on a worksheet included in IRS Publication 590-A. Finally, if your income exceeds the phase-out limit, you are ineligible for a traditional IRA deduction in 2018.

If you don't participate in a retirement plan at work, such as a 401(k), 403(b), or pension plan, your ability to take advantage of the traditional IRA deduction is only limited if you're married and your spouse participates in an employer's plan. In this case, the income limits are:

Data Source: IRS.

What it means to the average American

Americans in the 50th income percentile are in the 15% marginal tax bracket for most filing statuses, as of the latest IRS data. This means that taking full advantage of the traditional IRA tax deduction could save the average American $825 per person on their federal tax bill in 2018. This is in addition to any state or local tax savings.

What's more, individuals in higher tax brackets could save even more by taking full advantage of the IRA tax deduction. For example, an eligible individual in the 25% tax bracket could save $1,375, or $1,625 if they're 50 or older. And married couples can take the deduction for each eligible spouse.

If you were to contribute $5,500 to an IRA every year for 30 years, and your investments produced a historically conservative 7% annualized return, you could end up with a $520,000 nest egg -- and will have either gotten tens of thousands of dollars in tax savings along the way, or will be able to withdraw the money tax-free if you used a Roth IRA. The combination of tax breaks and retirement security is why I often refer to retirement saving as the single smartest tax move that most Americans can make.

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