Despite the prevalence of 401k plans offered by many employers, Individual Retirement Accounts – or IRAs as they’re better known as – remain one of the most popular retirement savings tools in America.
It’s not surprising why since IRAs enable almost anyone to save money for retirement – and possibly save on their taxes while doing so.
Traditional IRA Contribution Criteria
The criteria for contributing to an IRA is simple: If you or your spouse earns taxable income in a given year and you’re under 70½ years of age, you can contribute money to an IRA. That’s it!
Whether you can reduce your taxes by contributing to an IRA is a little bit more complicated. This depends on several different factors, starting with your access to a retirement plan where you work. If your employer doesn’t offer a retirement plan (such as a 401k plan), you can deduct the entire amount of your annual IRA contribution on your federal income tax return, which may reduce the amount of taxes you pay.
If your spouse doesn’t work outside the home, he or she can also contribute to a separate IRA and deduct the contribution, up to the annual contribution limit. In 2017 and 2018, this limit is $5,500 or $6,500 if your spouse is 50 years of age or over.
However, if your employer offers a retirement plan, your ability to deduct your IRA contributions will depend on how much money you earn. In this scenario, your deduction will start to phase out once your adjusted gross income (AGI) reaches $63,000 if you’re single or $101,000 if you’re married and file a joint tax return. The deduction vanishes once your AGI reaches $73,000 if you’re single or $121,000 if you’re married and file jointly.
Make Contributions Strategically
The deadline for making contributions to IRAs for tax year 2017 is April 17, 2018. This means you still have time to potentially lower your 2017 tax bill by making a tax-deductible IRA contribution if you qualify. You can even open a new IRA if you don’t have one between now and April 17 and make contributions for tax year 2017.
If you haven’t yet maxed out IRA contributions for 2017, it probably makes sense to allocate contributions you make between now and April 17 to tax year 2017. For example, if you’re 40 years old and you’ve contributed $4,000 to your IRA so far in tax year 2017, try to make an additional $1,500 contribution for tax year 2017 before the deadline.
Conversely, if you have already maxed out IRA contributions for tax year 2017, be sure you allocate any contributions you make between now and April 17 to tax year 2018. This will enable you to get a jump start on retirement saving this year and potentially maximize tax savings on your 2018 return.
Automate Your Contributions
One way to ensure that you max out IRA contributions every year is to arrange for money to be transferred from a checking account into your IRA electronically each month. This way, you don’t have to think about it – your contributions are made automatically. Sometimes this is referred to as “paying yourself first.”
For example, if you’re 40 years old, you can contribute up to $5,500 to your IRA in tax year 2018. Let’s assume you make your first 2018 contribution in March, which gives you 14 months to max out contributions for tax year 2018. Dividing $5,500 by 14 months reveals that by contributing about $392 every month, you’d max out your IRA this year.
Or you could contribute $550 every month and max out contributions for 2018 by the end of the year ($5,500/10). Then you could adjust this to about $458 a month next January ($5,500/12) to max out contributions for 2019 and subsequent years. Note that the annual contribution limit could be adjusted in the future to account for inflation, so be sure to factor this into your planning.
Now is a great time to plan your IRA contribution strategy for tax years 2017 and 2018. Be sure to speak with a tax professional for more details about the deductibility of IRA contributions given your particular circumstances. For more information, check out the IRS website.
Learn more about taxes, retirement accounts, and how they fit into your holistic financial life by reading our free guide Personal Capital Tax Guide for Holistic Financial Planning.
This blog is for informational purposes only; we are not in the business of providing specific tax or legal advice and we generally recommend seeking the advice and counsel of a tax professional before taking any action that may cause a material taxable event.
Paul Deer, CFP®
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