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Looking to Save on Taxes? Contributing to an IRA Before Tax Day May Help

  |  By Deanna Fong

Tax season is here and that means many Americans are searching for ways to lower their tax bill. One way you may be able to take a deduction is by opening a Traditional IRA and making a contribution to your new retirement account by Tax Day.

Contributing to a Traditional IRA allows you to build your nest egg with the added benefit of tax savings because your annual contribution may count as a tax deduction. If you are considering opening a Traditional IRA to make a deductible contribution, here is what you need to know:

Who can open a Traditional IRA?

Generally speaking, anyone who is under the age of 70½ can open a traditional IRA, but there are income eligibility requirements for funding a Roth IRA. You are also allowed to have multiple retirement accounts. That means if you already participate in a 401(k) plan through your employer, you may still be eligible to open an IRA to save for retirement.

But you must have taxable income during the year to contribute to an IRA (more on that below).

Traditional IRA or a Roth IRA?

If you are considering opening an IRA in the hopes of getting a tax deduction on your 2016 taxes, you would need to open a traditional IRA. Traditional IRAs may be funded with pre-tax dollars and earnings in the account are allowed to grow tax-deferred. That means annual contributions to a traditional IRA may be deductible, depending on your income and whether or not you or your spouse already participate in a retirement plan at work.

On the flip side, annual contributions to Roth IRAs are not tax deductible because you make contributions to the account with after-tax dollars. However, you are able to make tax-free withdrawals from the account once you hit the age of 59½. [1]

This handy chart from the IRS offers a side-by-side comparison of traditional and Roth IRAs, outlining who can contribute, how much you can contribute and when you can withdraw your money.

There are several factors to consider when choosing between a traditional IRA or a Roth IRA. One determining factor that is often touted is based your short-term and long-term financial picture. For example, if you expect you'll find yourself in a lower tax bracket after you retire, a traditional IRA may make more sense because contributions made today are deductible. But if your tax rate is likely to climb as you head into retirement, you may favor a Roth IRA because your withdrawals will not be taxed.

Do I qualify to make an IRA contribution?

You must have taxable income during the year to contribute to an IRA. This income includes wages, salaries, tips, commissions and bonuses. Self-employment income is also included. Interest, dividends, rental income and proceeds from life insurance policies are some examples of what is not classified as taxable income.

How old do I have to be to contribute to an IRA?

There is no minimum age requirement for opening and contributing to an IRA. But, as I noted in my answer to the question above, you must have taxable income on your income tax return to contribute to an IRA.

However, there is an age maximum for contributing to a traditional IRA. You must be under the age of 70½ at the end of the given tax year to contribute to a traditional IRA. Once you reach 70½ you are required to begin taking Required Minimum Distributions (RMDs) based on your life expectancy. (If you want to learn more about RMDs, you can read about the 6 most frequently asked questions that we receive from clients here.)

There is no maximum age for contributing to a Roth IRA.

What are IRA contribution limits?

For tax year 2016, if you are under the age of 50, you are allowed to contribute up to $5,500 into an IRA. If you are 50 and over the IRS allows you to contribute up to $6,500. The contribution limits are the same for tax year 2017. Contributions for 2016 tax year can be made until April 18, 2017, excluding any tax filing extensions. (While April 15 is the typical due date for contributing to an IRA, the date has been pushed back this year.)

Starting January 1, 2017, you can also begin making a current year contribution. This means between January 1st and April 18th, you can make a combined IRA contribution of $11,000 if you’re under 50 and $13,000 if you are 50 and over, if you qualify.

When should I open an IRA?

This is always a personal decision that should take into account your current financial situation and your long-term savings goals. If you're considering opening an IRA and you want the possible tax deductions for 2016, you have to open and make a contribution to your account before April 18.

At PENSCO we custody real estate, private equity and notes through a self-directed IRA. Interested in learning more about how IRAs work and alternative investments? Download our free IRA Investors Guide:

[1] Tax free earnings are dependent upon compliance with IRS rules for withdrawals from Roth IRAs, which are outlined here.

 

This blog is intended for general and or educational purposes only and is not intended as investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”). Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.