There is still time for retirement savers to reduce their 2016 tax bill. Workers have until April 18, 2017, to make an individual retirement account contribution that will qualify for a tax deduction on their 2016 tax return. When preparing your tax return, you can plug in an IRA contribution to see how much it reduces the tax you owe or boosts your refund. Here’s how to decrease your income tax bill by saving for retirement in an IRA.
[See: How to Max Out Your 401(k) in 2017.]
Claim a tax deduction. Workers can defer paying income tax on as much as $5,500 that they contribute to an IRA. The dollar value of this tax deduction depends on your income tax rate. A worker in the 25 percent tax bracket will reduce his tax bill by $1,375 if he maxes out a traditional IRA. Higher-income workers in the 35 percent tax bracket get an even bigger tax break of $1,925 for the same contribution amount, while those with modest incomes who pay a 15 percent income tax rate could save $825 on their income tax bill.
“Because you don’t have to use after-tax dollars for the savings in a deductible IRA, in effect the government is helping fund the account,” says Barbara Weltman, an attorney and author of “J.K. Lasser’s 1001 Deductions and Tax Breaks 2017.” “If you are in the 25 percent tax bracket, then in a sense, a quarter of your contribution is being paid by the government.” You can contribute to more than one IRA in the same year as long as your total contributions don’t exceed $5,500 for the year. Income tax won’t be due on this money until it is withdrawn from the account.
Older workers get a bigger deduction. Workers age 50 and older can contribute an additional $1,000 to an IRA, for a total tax-deductible contribution of $6,500 in 2016. The tax deduction for older workers who max out their IRA ranges from $975 for those in the 15 percent tax bracket to $2,275 for employees who pay a 35 percent income tax rate.
[See: How to Reduce Your Tax Bill by Saving for Retirement.]
Make sure you qualify. If your employer doesn’t provide a 401(k) plan or similar type of retirement account, you can make tax-deductible contributions to an IRA regardless of your income level. However, the tax deduction for IRA deposits is phased out for those who are eligible for a 401(k) plan and have a modified adjusted gross income between $61,000 and $71,000 for individuals and $98,000 to $118,000 for couples in 2016. “If you are already in a retirement plan with an employer, your income has to be below that limit if you want a tax deduction for contributing to an IRA,” Weltman says. “If you don’t have a retirement plan at work, your income is not an issue.” When only one member of a married couple has a 401(k) account, the tax deduction is phased out when the couple’s income is between $184,000 and $194,000 in 2016. You also need earned income in order to save in an IRA. And people age 70 1/2 and older are no longer eligible to claim a tax deduction for their IRA contributions.
Contribute in each spouse’s name. Married couples can double their tax deduction if they max out an IRA in each spouse’s name. “Even if only one spouse works, you can contribute for the non-earning spouse,” Weltman says. Your combined contributions to both IRAs can be as much as $11,000 if you’re both under age 50, $12,000 if one spouse is 50 or older and $13,000 if you’re both at least age 50.
Specify which year the contribution should be applied to. While 401(k) contributions are typically due by the end of the calendar year, you have until the tax filing deadline in April to make IRA contributions. “The IRA has the triple benefit of reducing your taxable income and saving you taxes, it can grow tax-free and you can do it after the end of the year,” says Mark Steber, the chief tax officer for Jackson Hewitt Tax Service. “It is one of the only tax breaks that you can do after the fact.” However, when you make a deposit between Jan. 1 and April 18, you will need to specify whether you want the contribution to be applied to tax year 2016 or 2017. Financial institutions may automatically apply a deposit to the calendar year in which it was received unless you indicate otherwise.
Contribute your tax refund to an IRA. Consider depositing part or all of your tax refund directly into an IRA using IRS Form 8888. You can file a tax return claiming a traditional IRA contribution before the money is actually in the account as long as you make the deposit by the due date of your tax return. “You can take a deduction on your tax return for something you have not even done yet,” Steber says. “You can file your tax return, you can take that refund and then go fund your IRA up until April 18.”
[Read: 5 New 401(k) and IRA Rules for 2017.]
Claim the saver’s credit. Low- and moderate-income workers who save for retirement are eligible to claim the saver’s tax credit in addition to the tax deduction for their IRA contribution. If your adjusted gross income is below $30,750 as an individual, $46,125 as a head of household or $61,500 as a couple in 2016, you might be eligible for a tax credit worth between 10 and 50 percent of the amount you contribute to an IRA up to $2,000 for individuals and $4,000 for couples. “You have to meet certain income requirements that are kind of low,” says MaryAnn Monforte, a professor of accounting at Syracuse University’s Whitman School of Management. “If you qualify, it’s a great way to get a deduction for your contribution and on top of that a tax credit.”
Emily Brandon is the author of “Pensionless: The 10-Step Solution for a Stress-Free Retirement.”
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How Saving in an IRA Can Reduce Your 2016 Tax Bill originally appeared on usnews.com
