It’s tax season again — and we know that that means: If you’ve reduced your withholding so the IRS doesn’t get a free loan on your money, you might owe a little on your taxes. Or a lot.
But, there’s good news: If you’re looking to decrease the burden of your 2015 tax filing or get more money back, look no further than this simple step to reduce your taxes!
Add money to an IRA
According to the IRS, you still have time to contribute to an IRA — up until April 18, 2016, for your 2015 tax year:
“…you have until April 18, 2016, to make your 2015 contribution, but please see IRS Publication 509, Tax Calendars, for how statewide holidays may delay this deadline to April 19, 2016,” says the IRS on its website.
Depending on how much you want to adjust your tax burden and if you already have a retirement plan at your job, contributing to an IRA might be one way to reduce your taxes.
How to reduce your taxes by $1,000 or more
Let’s do a simple example. Say your income was $100,000, and you had no other deductions, such as mortgage interest or charitable contributions, and you do not have a retirement plan at work. Your estimated taxes for the year would be $16,016. If you already paid $15,000, then you still owe $1,016.
But, if you contributed or can contribute the max of $5,500 ($6,500 if you’re 50 or over) to a traditional IRA account before you file your taxes, you’d get about $359 back on your federal taxes! By saving for your own retirement, you’d save an estimated total of $1,375.
That’s free money you would have otherwise never seen again, but since you contributed to your retirement through an IRA, it’s yours!
Here’s another example.
Say you earned $50,000 with no other itemized deductions, but you do have a retirement plan at work. In this case, your total taxes would be about $4,859. Let’s say you already withheld $4,000, so you still owe $859. If you decided to contribute $5,500 to a traditional IRA, this would reduce your total tax bill to just $34 owed. That’s about $825 saved that would have been gone forever, but since you put aside money for retirement, it’s money in your pocket.
Already have a retirement plan at work?
If you already have a retirement plan at work, you may not be able to use the IRA deduction.
If you are single and have a modified adjusted gross income (AGI) of $61,000 or less, or if you are married or a qualified widower making $98,000 or less, you can take the full deduction up to your contribution limit ($5,500, or $6,500 if you are 50 or over). If you are single and had an AGI of more than $61,000 but less than $71,000, or if you are married or a qualified widower and made more than $98,000 but less than $118,000, you can claim a partial deduction. But, if you are single and made over $71,000, or married or a qualified widower making $118,000 or more, you cannot claim a deduction.
Check the IRA deduction limits on the IRS website for more information. You can also get more info on the required tax forms here.
RELATED: IRS Free File program lets you access free tax software
The difference between traditional and Roth IRAs
So what is the difference between a traditional and a Roth IRA?
Unfortunately, if you contribute to a Roth IRA, it is not deductible on your taxes. But, these other benefits are what make Roth IRAs super valuable:
- If you satisfy the requirements, qualified distributions and earnings are tax-free (you don't get taxed on the money you withdraw in retirement).
- You can make contributions to your Roth IRA after you reach age 70 ½.
- You can leave amounts in your Roth IRA as long as you live.
Roth IRAs are valuable because we don’t have to pay taxes on the money we withdraw later on in retirement, making them a great investment choice! For traditional IRAs, the benefit is the tax deduction now.
In addition, you can keep your dollars in a Roth IRA for as long as you'd like. With a traditional IRA, you have to begin making yearly withdrawals from your account once you reach 70 ½.
For both traditional IRAs and Roth IRAs, if you withdraw funds before you reach age 59 ½, you’ll face a 10% penalty from the federal government, in addition to any taxes you’ll have to pay.
For more on the differences, watch Clark's video on IRAs!
RELATED: What is a backdoor Roth IRA?
Using IRAs for qualified expenses
IRAs are also valuable because you can use them for qualified expenses without the 10% penalty before you reach age 59½, such as a first time home purchase or medical expenses.
For a first-time home purchase, these are the rules:
- Traditional IRA: $10,000 penalty-free withdrawals to cover first-time homebuyer expenses, but taxes due on distributions.
- Roth IRA: After five years, up to $10,000 of earnings can be withdrawn penalty-free to cover first-time homebuyer expenses.
For medical expenses, you may not have to pay the 10% additional tax if you have unreimbursed medical expenses that are more than 10% (or 7.5% if you or your spouse was born before January 2, 1951) of your adjusted gross income, or you are totally and permanently disabled.
Check the IRS' website for other exceptions.
RELATED: Get 12 more years in retirement with one simple tip
Other tax deductions through the Saver’s Credit
Even if you have a Roth IRA or are already saving in an employee-sponsored retirement plan, there is another tax credit you can receive called the Retirement Savings Contributions Credit.
This tax credit is available to people who are age 18 or older, not a full-time student and not claimed as a dependent on another person’s return. According to the IRS, “The amount of the credit is 50%, 20% or 10% of your retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on your adjusted gross income,” and it can be used for your contributions to any of these retirement plans: Traditional or Roth IRA; your 401(k), SIMPLE IRA, SARSEP, 403(b), 501(c)(18) or governmental 457(b) plan; and your voluntary after-tax employee contributions to your qualified retirement and 403(b) plans.
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