If you’re worried that you’ll owe income tax this year, there's a financial move you can still make in order to reduce your taxable income before April 15th.
Contribute to Your Traditional IRA
You may be able to lower your taxable income by contributing to your traditional IRA. There's usually a date by which you can contribute to your IRA, and the resulting deduction will affect your previous year's taxes, not the current (in progress) year. For example, if you contributed by April 18, 2022, the resulting deduction affected your 2021 taxes, not your 2022 taxes.
There are a few conditions you have to meet to make sure you’re eligible for this deduction. Essentially, if you or your spouse is covered by an employer-sponsored retirement plan at work AND your adjusted gross income exceeds the limit set by the IRS, you may not be eligible. Keep in mind that these numbers may change slightly from year to year. You can always check the current figures here on the IRS website.
To make sure your contribution qualifies for a tax deduction, you must meet the following criteria:
- You are NOT eligible to participate in your employer’s company retirement plan.
- BUT if you are eligible for a company plan and your adjusted gross income is $63,000 or less, you still qualify.
- BUT if you are eligible for a company plan and your adjusted gross income is $101,000 or less for a married couple filing jointly, you still qualify.
- BUT If your spouse is eligible for a company plan and your combined gross income is $184,000 or less, you still qualify.
The maximum amount you can contribute to your IRA is $5,500. This limit gets bumped up to $6,500 if you're 50 or older. These limits have been the same for tax years 2015-2018, but you can always check the current contribution limits here on the IRS website.
How Much Can You Save?
First, you’ll need to calculate your taxable income. Once you know your taxable income, the IRS tax tables will tell you which tax bracket you fall into. Your tax bracket tells you what percentage of tax you’ll pay on that income. For example, if you fall into the 25% tax bracket, you are expected to pay 25% of your taxable income.
Next, multiple your tax bracket percentage by the amount you’re planning to contribute to your IRA. The result is how much you’d knock off your taxable income.
Let’s say you’re in the 25% tax bracket and you realize that if you were to file today, you’d owe $2,000 in income tax. If you were to make a $5,000 payment into your IRA, you would reduce your taxable income by 25% of that $5,000, for a total of $1,250. When you subtract that $1,250 from the $2,000 you would owe, you get $750. That’s the new amount of tax you would owe.
Of course, you’d have to write that $5,000 check to make this happen. But the upshot is that you’re essentially paying yourself. That money is socked away for retirement, earning compound interest every day until you withdraw it.
What about a Roth IRA?
While contributing now will help you start compounding interest right away, it’s not going to reduce your taxable income for 2016. Roth IRA contributions are not tax-deductible. The upside is that the money you contribute now will come back to you tax-free when you retire and begin taking distributions. No matter which type of IRA you have, you benefit in the long run.
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This material was not intended or written to be used, and cannot be used, to avoid penalties imposed under the Internal Revenue Code. Always consult with your independent advisors regarding your particular financial and legal situation. The material here is presented for informational purposes only and should not be construed as tax or legal advice. Consult all policy documentation or your agent for details.