With Tax Day quickly approaching (April 18, 2023), you may hear a lot of talk about Individual Retirement Accounts (also known as IRAs). An IRA is a type of investment account that allows you to save money for retirement on a tax-advantaged basis, but what does that have to do with tax season? Depending on the type of IRA you choose, you may be able to take a dollar-for-dollar reduction in your income when you contribute to an IRA.
For example, if you contribute $6,000 (the limit for those under the age of 50) to a traditional IRA for the 2022 tax year, you can reduce your taxable income by $6,000. This can be particularly beneficial if you’re in a higher tax bracket and want to lower your tax bill while saving for the future.
If you’re age 50 or older, you may also be eligible to make catch-up contributions to your IRA. For the 2022 tax year, taxpayers 50 and older can contribute an additional $1,000 (over the $6,000 limit) to their IRA. This can be a great way to boost your retirement savings if you’re getting a late start or if you’re trying to make up for lost time.
But that’s not the only reason to consider opening an IRA or contributing to an existing one right now. In addition to reducing your taxable income, contributing to an IRA can also help you take advantage of tax-deferred growth. This means that any investment earnings in your IRA won’t get taxed until you withdraw them in retirement. Over time, this can help your savings grow more quickly than if you were investing in a taxable account.
By contributing to an IRA before tax season, you can help ensure that you’re on track to meet your retirement savings goals. The earlier you start, the more time your investments will have to grow. By contributing to an IRA regularly, you can help ensure that you’re saving enough to live comfortably in retirement.
If you’re thinking of opening an IRA ahead of the filing deadline, there are a few things to keep in mind:
- There are limits to what accounts you can open and how much you can contribute. If you have a Roth IRA, how much you can save depends on your income and filing status. For example, if you’re single, you can contribute up to $6,500 assuming you make less than $138,000. If you’re married and filing taxes together, you can contribute up to $6,500 if you make less than $218,000.
- If you have a traditional IRA and you’re not covered by a retirement plan through your employer, you can deduct the full amount you contribute from your taxable income. But if you make more than $68,000, your deduction starts to go down. If you’re married and covered by a plan at work, you can only deduct the full amount if your income is less than $109,000. The deduction limit is between $204,000 and $214,000 (for 2023) if you’re not covered by a plan, but your spouse is.
- You don’t have to be a big earner to benefit from IRA contributions. The Retirement Savings Contributions Credit (a.k.a., the saver’s credit) is a tax credit designed to encourage low- to moderate-income earners to save for retirement. The credit is based on your contributions to a qualified retirement account, such as an IRA or a 401(k). The credit can be worth 10%, 20%, or even 50% of the total amount you contribute, up to a maximum contribution of $2,000 per person (or $4,000 per married couple filing jointly). The exact amount of the credit you can receive depends on your adjusted gross income (AGI). The lower your AGI, the higher the credit percentage you can get.
- You can rollover money from an old 401k into an IRA—but use caution. If you change jobs or retire from a job where you held a 401k, you may be left with an orphan 401k (a plan that no longer has a sponsor). You can roll that 401k into an IRA, but to avoid paying taxes, it’s wise to do a direct rollover instead of cashing it out or doing an indirect rollover. If your former employer or investment company cuts you a check, you may be taxed on the funds and you may be required to pay a penalty for early distribution. If you do a direct rollover, the money is technically never in your hands and there is less likely to be immediate tax implications.
The bottom line is before you make any decisions about moving money, talk to a tax professional who understands your particular situation to determine whether you are eligible for a deduction or tax credit on your IRA contribution.
It’s also worth noting that you only have until April 18, 2023, to make contributions to your IRA for the 2022 tax year. This means that while the window is short, there’s still time to make contributions and potentially reduce your tax bill for the previous year.