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There’s still time to reduce your 2016 tax bill as you take steps to maximize the benefits of saving money for retirement. There are different strategies that can save money or defer taxes through contributing to IRAs and retirement funds each tax year. For the 2016 tax year, you have until April 18th to make a move. However, if you do make a qualifying IRA contribution between January 1 and April 18, make certain you specifically instruct your financial institution to apply the deposit to the 2016 tax year. Otherwise, the deposit may automatically be considered a 2017 deposit.
Using a Tax Refund for Tax Savings Here’s another tip regarding your tax refund and saving for retirement: consider depositing all or part of your tax refund directly into an IRA. It saves a step by directly depositing the money, it can speed up the timing of the contribution and ensures the deposit is made as you intend. With a direct deposit, you can even choose to use your 2016 refund to pay for the amount of your 2016 IRA contribution as long as the tax return can be processed and the refund paid before the April 18th deadline. You would designate on Form 8888 “Allocation of Refund” how much of your refund should be deposited directly into your IRA and that it should be designated as your 2016 contribution.
How Much You Can Save A working taxpayer can defer paying income tax on a contribution of pre-tax dollars up to $5,500 to a Traditional IRA and may split contributions to more than one IRA. Income tax won’t be due on the money until it is withdrawn from the account. Contributions to a Roth IRA are after-tax dollars and do not qualify for a tax deduction, though qualified distributions may be withdrawn tax-free at retirement. Contributions to both Traditional and Roth IRAs are limited depending upon modified adjusted gross income.
The actual amount of the tax deduction on a Traditional IRA depends upon the taxpayer’s income tax rate. For example, a worker in the 25% tax bracket may save $1,375 in income taxes by making the maximum IRA contribution. Workers in the 35% tax bracket may save $1,925 for the same contribution amount.
If you are age 50 and above, you may contribute an additional $1,000 to an IRA up to a total tax-deductible contribution of no more than $6,500. For example, the tax deduction can range from $975 for individuals in the 25% income tax bracket to $2,275 for those who are in a 35% tax bracket.
Married couples can double their tax deduction if they make the maximum contribution to an IRA in each spouse’s name. Even if one of the spouses doesn’t work, a contribution can be made for that spouse subject to the spousal IRA limit. The combined contributions must be no more than $11,000 if both are under age 50, $12,000 if one spouse is 50 or older and $13,000 if both are at least 50 years old.
Who Qualifies For Tax Deduction A taxpayer must earn income in order to save in an IRA. If a worker has no retirement plan at work, the tax deduction for Traditional IRA contributions is allowed in full regardless of income. If a person or spouse has a retirement plan at work, the tax deduction and the contributions may be limited. Amounts for both the allowable deduction and contributions phase out at higher income levels calculated as modified adjusted gross income.
People aged 70 ½ and older may no longer claim a tax deduction for their contributions to Traditional IRAs. Upon reaching that age, the fund’s owner must start taking required minimum distributions (RMDs). Any deductible contributions and earning withdrawn from a Traditional IRA are taxable. Early withdrawals by a person under the age of 59 ½ may be subject to a 10% penalty. Contributions made to a Roth IRA can be made after age 70 ½ and the amount in the account can be left there as long as the person lives. Qualified distributions are generally not taxable, but early withdrawals are subject to a 10% penalty.
Click here for a description of the difference between Traditional and Roth IRAs.
