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How to Boost Your Tax Savings with Last-Minute IRA Contributions

How to Boost Your Tax Savings with Last-Minute IRA Contributions

March 01, 2023

Are you looking for a smart way to lower your tax bill and boost your retirement savings?

 

 If so, it's time to learn more about Individual Retirement Accounts (IRAs) and the benefits of contributing to them before April 18th to qualify for a deduction on your 2022 tax return. An IRA is a powerful investment tool that can help you grow your money over time while deferring taxes. Whether just starting your career or nearing retirement, contributing to an IRA can help you achieve your financial goals and secure your future. In this blog post, we'll explain what IRAs are, the different types available, and the tax advantages they offer. We'll also provide tips on choosing the right IRA for your needs and maximizing your contributions before the tax deadline. So, keep reading to learn about IRAs to make the most of your retirement savings and reduce your tax bill.

What is an IRA?

 

An Individual Retirement Account (IRA) is a type of savings account designed to help individuals save for retirement. Several types of IRAs are available, including Traditional IRAs, Roth IRAs, Simple IRAs, and SEP IRAs.

 

Traditional IRAs, Simple IRAs, and SEP IRAs are for individuals who want to reduce their taxable income while saving for retirement. Contributions to these types of IRAs are pre-tax, which means they can reduce an individual's taxable income for that tax year. However, the contributions and earnings on the contributions are taxed once the individual withdraws the money from the account.

 

On the other hand, Roth IRAs are funded with after-tax dollars, which means that contributions are not tax-deductible. However, the earnings on the contributions grow tax-free, and qualified withdrawals can also be made tax-free.

 

Additionally, IRAs can offer a wide range of investment options, including stocks, bonds, and mutual funds, which can help individuals to grow their retirement savings over time.

 

It's important to note that rules and restrictions are associated with contributing to and withdrawing money from an IRA. For example, there are annual contribution limits, and there may be penalties for withdrawing money from an IRA before age 59 ½. Therefore, it's essential to understand these rules and restrictions before opening an IRA and to consult with a financial advisor to determine the best retirement savings strategy for your specific situation.

 

Types of IRAs and their Contribution Limits

 

There are several different types of IRAs, including the Simple IRA, SEP IRA, Traditional IRA, and Roth IRA. Each has unique features and benefits, so it's essential to understand the differences between them before deciding which one is right for you.

1.   Simple IRA

A Simple IRA, or Savings Incentive Match Plan for Employees IRA, is a type of retirement plan designed for small businesses and self-employed individuals. It is similar to a 401(k) plan in that it allows employees to contribute a portion of their salary, and the employer may also contribute. Contributions are tax-deferred, the earnings grow tax-free until withdrawal, and the account holder must start taking required minimum distributions (RMDs) at age 72.

  • Contribution Limit: For 2022, the contribution limit is $14,000 ($17,000 if you're 50 or older). Employers can also make contributions on behalf of their employees with a 3% match or a straight contribution of 2% of salary.
  • Deductibility: Employee contributions are made pre-tax and are automatically deducted from your income for the current year, and employer contributions are tax-deferred until withdrawal to the employee with no tax deduction.

 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-simple-ira-contribution-limits

2.   SEP IRA

 A SEP IRA, or Simplified Employee Pension IRA, is another type of retirement plan designed for small businesses and self-employed individuals. Only the employer can contribute with a SEP IRA, and contributions are tax-deductible. The earnings grow tax-deferred until withdrawal, and the account holder must start taking required minimum distributions (RMDs) at age 72.

  • Contribution Limit: For 2022, the contribution limit is the lesser of 25% of compensation or $61,000.
  • Deductibility: SEP IRA contributions are tax-deductible for the employer. If you are self-employed and contribute to a SEP IRA, you can deduct the contributions as an adjustment to income on your tax return.

 https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep

 

3.   Traditional IRA

 A Traditional IRA is a retirement account that allows individuals to make tax-deductible contributions up to a specific limit each year. The earnings grow tax-deferred until withdrawal, but withdrawals get taxed as ordinary income. The account holder must start taking RMDs at age 72.

  • Contribution Limit: For 2022, the contribution limit is $6,000 ($7,000 if you're 50 or older).
  • Deductibility: If you or your spouse do not have access to a retirement plan through your employer, you can deduct the total contribution on your tax return. If you or your spouse have access to a plan, the amount you can deduct is based on your income and filing status.

 https://www.irs.gov/retirement-plans/traditional-iras

4.   Roth IRA

A Roth IRA is a retirement account that allows individuals to make after-tax contributions up to a specific limit each year. The earnings grow tax-free, and qualified withdrawals are also tax-free. Unlike a Traditional IRA, there are no required minimum distributions with a Roth IRA, so the account holder can continue to let the earnings grow tax-free for as long as they like.

  • Contribution Limit: For 2022, the contribution limit is $6,000 ($7,000 if you're 50 or older).
  • Deductibility: Roth IRA contributions are not tax-deductible, but you can withdraw the money tax-free in retirement.
  • Income Limits: (Based on modified AGI) If file taxes as married and are making more than $214,000 you cannot contribute to Roth IRA. If you file single, then the limit is $144,000.00.

 https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2022

 

The Deadline for IRA Contributions and Deductions

 

If you're looking to reduce your tax bill and save for retirement, contributing to an Individual Retirement Account (IRA) can be a smart financial move. Not only does it offer a tax-advantaged way to save for your future, but it can also provide you with an opportunity to lower your tax bill for the current year.

 

Knowing the deadline for contributing to your IRA and receiving a deduction on your 2022 tax return is essential. The deadline for making contributions for the 2022 tax year is April 18, 2023.

 

Why is this deadline so important? That's because the contributions are tax-deductible (except for Roth IRAs), meaning you can deduct the contribution amount from your taxable income on your tax return.

 

For example, let's say you're single, and your taxable income for 2021 is $50,000. If you contribute $6,000 to your traditional IRA before the April 18 deadline, you can deduct that amount from your taxable income, reducing it to $44,000.

 

The April 18 deadline for IRA contributions and deductions is essential to keep in mind if you want to reduce your tax bill and save for retirement. You can save hundreds or even thousands of dollars in taxes by making contributions before the deadline. Just be sure to consult a financial advisor if you need help determining which type of IRA is right for you and make sure they work with your CPA to make sure everything is filed correctly.

 

Tips for Maximizing Your IRA Contributions and Deductions

 

Contributing to an Individual Retirement Account (IRA) is a great way to save for retirement and reduce your tax bill. However, if you want to get the most out of your IRA contributions and deductions, it's crucial to have a solid savings strategy in place. Here are some tips for maximizing your IRA contributions and deductions:

 

Max Out your Employer Match:

 Before contributing to a personal Traditional or Roth IRA, make sure you max out any employer matches within your company’s retirement plan. If you have access to a 401(k), 403(b), Simple IRA, or any other employer retirement plan, it is highly likely that your employer will match your contribution up to a certain percentage of your paycheck. For example, if your company offers a 3% match, that means that for every dollar that you contribute to the plan, the employer will put in a dollar as well up to 3% of your salary. In most cases, this money is 100% yours with no vesting schedules, a reward for saving for the future. Don’t leave this free money on the cutting room floor.

 

 Establish an Investment Tax Strategy

When you make a traditional contribution to your 401k or traditional IRA you are funding that account with pre-tax money. Meaning you can deduct that money from your current year's taxable income and defer the taxes until you withdraw the money. The advantage here is that it will grow tax-deferred, so no capital gains to worry about, and the idea is that your taxable income will be lower in retirement when you are withdrawing these funds. On the other hand, with Roth contributions you are funding the account with after-tax money, meaning you have already paid income taxes and cannot deduct anything from your current taxable income. In this situation, you still get the fantastic benefit of tax deferral, and if it is a qualified withdrawal then you will not need to pay any taxes on this money. If you do not need the tax deduction, I recommend going with a Roth contribution, as tax rates are likely to increase over time.

 

Set up automatic contributions:

One of the easiest ways to maximize your IRA contributions is to set up automatic contributions. This way, you won't have to remember to contribute each month and will be less likely to spend the money elsewhere. You can set up automatic contributions and choose to contribute a fixed amount or a percentage of your income.

Take advantage of catch-up contributions:

 If you're over 50 years old, you can contribute an additional $1,000 to your IRA each year up to $7,000 in 2022. Also known as a catch-up contribution, it's a great way to make up for any years when you couldn't contribute as much to your IRA.

 

In conclusion, maximizing your IRA contributions and deductions requires a solid savings strategy and commitment to regular contributions. By maxing out your employer matches, solidifying your investment tax strategy, setting up automatic contributions, and taking advantage of catch-up contributions, you will be prepared for the journey of meeting your retirement goals.