Individual retirement accounts were designed not only as a vehicle for retirement savings but also to provide tax advantages. If you are contributing to an IRA, you may be overlooking a few simple strategies for maximizing your account value and minimizing taxes on your withdrawals.
Contributions to traditional IRAs are tax-deductible, reducing the account owner’s taxable income during the contribution year. The earnings from those contributions will grow tax-deferred until the account owner makes withdrawals, potentially maximizing wealth accumulation over time.
“Contributing the annual maximum allowable amount for a traditional IRA will help reduce your earned income for taxes, but the most important part of doing this isn’t the tax deduction,” said Earl Yaokasin, a chartered financial analyst and owner of WealthArch Investment Services in Pasadena, California, in an email.
“Contributing as much as you can will help you save more for retirement and allow you to compound money faster, which translates to retiring sooner,” he added.
Maximize the Tax Deduction
For tax year 2024, savers can defer paying income tax on an IRA contribution up to $7,000 for those under 50, and $8,000 for those age 50 and older.
Income tax on this money isn’t due until the retirement saver makes a withdrawal. After age 59 1/2, there are no penalties for IRA withdrawals.
[Read: How to Save in a 401(k) and IRA in the Same Year]
Make Catch-up Contributions
Retirement savers over 50 shouldn’t miss the opportunity to contribute an extra $1,000 a year to their IRA.
“Taking advantage of this is very beneficial because when you are at that age, you are likely to be earning more, and being able to deduct more while in higher tax brackets will help you stretch your dollars even further,” Yaokasin said.
Meet the Contribution Deadline
The deadline for making IRA contributions typically falls on the tax filing deadline, usually April 15. However, that deadline may be extended to a subsequent business day if April 15 is on a weekend or holiday.
“If you make an IRA contribution after the deadline for a specific year has passed, it’s a big hassle to fix it,” said Yaokasin. “I’ve had a client do this and it was a mess. You definitely want to pay attention to the deadlines.”
[Related:New 401(k) Contribution Limits for 2024]
Contribute in Each Spouse’s Name
Married couples have the option to double the amount the household contributes to IRAs each year. If one spouse has no earned income or earns very little, the couple can still contribute to that spouse’s IRA.
“This means the household total IRA contributions could be up to $14,000 or $16,000 if you are both older than age 50,” said Daniel Milan, managing partner at Cornerstone Financial Services in Southfield, Michigan, in an email.
This strategy enhances retirement savings for both partners, boosting the total retirement savings amount and tax benefits for the couple. In the event of a divorce, the lower-earning spouse will have retirement assets in their name.
[Related:What Is the Average Retirement Savings Balance by Age?]
Claim the Saver’s Credit
A little-known provision of the tax code, the retirement savings contributions credit, also known as the saver’s credit, is available to workers with low to moderate earned income.
It provides a credit of up to $1,000 for individuals or $2,000 for a couple, based on their contributions. This helps mitigate taxes while also incentivizing retirement savings.
However, the saver’s credit has income limits based on a taxpayer’s adjusted gross income and marital or filing status.
For 2024, those income limits apply to:
— Married couples filing jointly with adjusted gross incomes up to $76,500
— Heads of household with adjusted gross incomes up to $57,375
— Married individuals filing separately and singles with adjusted gross incomes up to $38,250
Directly Deposit Your Tax Refund
Want to put your tax refund to work in your retirement savings without missing a beat?
By directly depositing your refund into your IRA, you can treat your tax refund like found money in addition to your earned income.
The immediate investment can also maximize your IRA’s growth potential since you can invest the money quickly without a bank transfer.
Make Sure You Qualify to Make IRA Contributions
To contribute to an IRA, you must have what’s considered earned income.
“Earned income can be wages, salaries, commissions, tips, bonuses and net income from self-employment,” said Nasha Knowles, a certified financial planner at Equitable Advisors in Atlanta, in an email.
Passive income such as rental income, interest and dividends don’t qualify as earned income, Knowles added.
If you or your spouse also participate in an employer-sponsored plan, such as a 401(k) or similar vehicles including a 403(b) or 457, there are limits to how much you can deduct from your taxes when contributing to an IRA.
Minimize Fees
Management fees can significantly reduce an account owner’s savings. While the fees may seem small, they can add up quickly.
“Avoid opening an IRA at a custodian that is going to nickel and dime you with administrative fees,” said Devin Carroll, owner and lead advisor at Carroll Advisory Group in Texarkana, Texas, in an email.
“Make sure to compare fees on investment products, as these come directly out of the return,” Carroll noted.
For example, you can find two similar funds tracking the same index, but one may have a substantially higher expense ratio, which reduces the return that goes into your pocket. In general, it makes sense to opt for the investment with the lowest fee when considering two similar products.
Consider a Roth IRA
A Roth IRA offers tax-free growth and withdrawals in retirement. Those advantages are available because contributions are made with after-tax dollars.
For tax year 2024, the contribution limits for an IRA are $7,000 for those under age 50 and $8,000 for those 50 and older.
Single filers with moderated adjusted gross income under $146,000 or married filing jointly with income under $230,000 are eligible to contribute to a Roth IRA.
“A Roth IRA contribution is a great way to use after-tax dollars to create tax-free retirement income after your working years,” Knowles said.
Minimize Taxes on Distributions
The IRS requires that retirement savers begin withdrawing from traditional IRAs at age 73.
Missing a required minimum distribution may result in penalties, which are entirely avoidable by keeping track of your withdrawals.
In addition, there are steps investors can take to minimize the taxes on their RMDs.
“For those who are charitably inclined, one method may be to use a portion of the RMD to make a qualified charitable distribution,” Carroll said. “These are excluded from income, thereby satisfying some or all of the RMD without adding income that could otherwise increase taxes or cause Medicare premium increases.”
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Update 05/15/24: This story was published at an earlier date and has been updated with new information.
