Perhaps you've heard that saving for retirement can save you some dough, come tax time. Cool, you think. That sounds great. I'll just put some money into some sort of retirement savings account and then on my tax return, I'll subtract the money in that account from my taxes. Or something like that?
It's all right if you're not certain how "retirement" translates to "sweet tax refund." For good reason -- it doesn't always. But it's really easy to figure out if contributing to certain retirement plans might help you reduce your tax liability, and we'll guide you through what plans might work (and how effective they might be).
Let's start with a little primer on IRAs, or individual retirement accounts. There are several different IRA plans, and each has its own advantages (or disadvantages) when it comes to your taxes. A Roth IRA is a great option for certain people. While there's no upfront tax break when you put money into your Roth IRA, when you start taking the money out of the plan (at retirement, presumably) you don't have to report it as income. The cash is yours alone, and no fraction is going to Uncle Sam. And you can contribute to a Roth at any age, as long as the money is income from a job [source: Malone].
What could be better than that? Well, perhaps a traditional IRA might tempt you, assuming you qualify. Unlike a Roth IRA, you can't take out contributions tax-free; you'll have to report them as income when you get your distributions. But what you can do is deduct the cost of the contributions from your adjusted gross income. So say you're putting $5,500 in your traditional IRA this year; you can turn around and take that amount off your income, and lower your tax responsibility (and possibly tax bracket).
But here's the rub: for one, that $5,500? That's the maximum you can contribute per year (in 2014), and thus deduct. If you're over 50, you can contribute a thousand dollars more. Moreover, you can't deduct all the cost if you're eligible for an employee retirement plan like a 401(k) unless your income (as a single person) is less than $60,000 and $96,000 if you're married and filing jointly. If you aren't eligible for a company plan but your spouse is, your household income needs to slide in under $181,000 to deduct all your contributions.
So it does depend a little on what you qualify for -- and what IRA plan you have -- when figuring out how contributions can affect your taxes. Just remember that a traditional IRA might result in deductions the year you put the money in, but Roth IRAs are going to be tax-free when you take that money out.
- Bell, Kay. "Traditional IRAs work fine for some filers." Bankrate.com. April 3, 2014. (Oct. 27, 2014) http://www.bankrate.com/finance/money-guides/traditional-iras-work-fine-for-some-filers-1.aspx
- Block, Sandra. "Fund an IRA, cut your taxes." Kiplinger. Feb. 1, 2013. (Oct. 27, 2014) http://www.kiplinger.com/article/taxes/T032-C005-S001-fund-an-ira-cut-your-taxes.html
- Fidelity. "Compare Roth IRA vs. Traditional IRA." 2014. (Oct. 27, 2014) https://www.fidelity.com/retirement-ira/ira-comparison?imm_pid=1&immid=00855&imm_eid=e41667806&buf=999999
- Investopedia. "Roth IRA." 2014. (Oct. 27, 2014) http://www.investopedia.com/terms/r/rothira.asp
- Investopedia. "Traditional IRA." 2014. (Oct. 27, 2014) http://www.investopedia.com/terms/t/traditionalira.asp
- Lambert, George D. "How IRA contributions affect your taxes." Investopedia. 2014. (Oct. 27, 2014) http://www.investopedia.com/articles/retirement/06/iraandtaxes.asp
- Malone, Matthew. "What is a Roth IRA." Rothira.com. 2012. (Nov. 9, 2014.) http://www.rothira.com/what-is-a-Roth-IRA
- TurboTax. "Tax tips after January 1st." Intuit. 2014. (Oct. 27, 2014) https://turbotax.intuit.com/tax-tools/tax-tips/Tax-Planning-and-Checklists/Tax-Tips-After-January-1--2015/INF12070.html
- Wang, Jim. "Reduce your tax liability with IRA contributions." U.S. News & World Report. Feb. 28, 2011. (Oct. 27, 2014) http://money.usnews.com/money/blogs/my-money/2011/02/28/reduce-your-tax-liability-with-ira-contributions