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Opening an IRA

Just because Tax Day might be on the horizon doesn’t mean it’s too late to dig up some extra savings on your taxes. Contributing to a traditional IRA for the current tax year is an easy way to score an additional deduction or a credit, both of which can cut your tax bill or pump up your refund, while also increasing your retirement savings. If you’re thinking of opening an IRA ahead of the filing deadline, there are a few things to keep in mind. For more help with retirement planning, consider working with a local financial advisor.

1. Traditional IRA Contributions Are Deductible.

A traditional IRA is funded using pre-tax dollars. That means that once you start taking distributions, you’ll have to pay taxes on the money at your regular rate. The upside is that you can deduct the money you put in, which can reduce your taxable income for the year. Note that you can deduct your IRA contribution even if you’re not itemizing deductions.

With a Roth IRA, contributions are made on an after-tax basis. That means you won’t be able to write off anything you save. The trade-off is that when it’s time to take the money out, you won’t owe any additional tax. Why? Because you’ve already paid the tax on the money you put in.

When you’re trying to decide which kind of IRA to open, consider both the short-term and long-term tax benefits. If you’re expecting to be in a lower tax bracket once you retire, taking the deduction now for a traditional IRA may yield the bigger tax benefit. If you think your tax rate will go up as you get older, paying the taxes on your Roth contributions now can save you money later on.

2. Your Tax Benefits May Be Limited.

Opening an IRA

The IRS has specific guidelines about who can open an IRA, including limits on Roth contributions and traditional IRA deductions. With a Roth IRA, your ability to save the full $6,000 allowed for the 2021 tax year is determined by your income and filing status. If you’re single, you can contribute the max as long as your adjusted gross income is less than $125,000. If you’re married and filing jointly, the limit goes up to $198,000. After these marks, your contribution limit will be reduced.

With a traditional IRA, single filers can write off the full amount regardless of what they earn, as long as they’re not covered by an employer’s retirement plan. For 2021, the deduction begins to phase out once their income passes $66,000. If you’re married and covered by a plan at work, you can only claim the full deduction if your joint income isn’t more than $105,000 for 2021. If you’re not covered, but your spouse is, the limit increases up to between $198,000 and $208,000 in 2021.

3. Lower-Income Workers Get an Extra Credit.

The Retirement Savings Contributions Credit is another tax incentive that’s geared specifically towards people who don’t earn huge amounts of income. The credit is good for 10%, 20% or 50% of your total IRA contribution up to $2,000, or $4,000 if you’re married and filing jointly. The amount of the credit you qualify for is based on your adjusted gross income (AGI).

For the 2021 tax year, single filers get the 50% credit if their AGI isn’t higher than $19,750. Once your income passes $33,000, you’re no longer eligible for the credit. Married couples can qualify for the 50% credit with a combined income of $39,500 or less. At the $66,000 mark, the credit is phased out entirely. For heads of households, the 50% contribution is attainable with an AGI below $29,625, with a complete phase-out at $49,500.

4. Make Sure You’re Choosing the Right Tax Year.

Opening an IRA

When you open an IRA before the tax deadline, you can make contributions for the previous or current year. To get the tax breaks come 2022, make sure you’re maxing out your contributions for 2021 first before saving anything for the next tax year. If you’re contributing to an IRA, the brokerage where you have your IRA account should allow you to indicate what tax year the contributions are for.

For 2021, the maximum IRA contribution is $6,000. People age 50 and older can make an additional $1,000 in catch-up contributions, for a total of $7,000. These are the same maximum contribution limits as for the 2020 and 2019 tax years.

Bottom Line

Although traditional and Roth IRAs are made for saving for retirement, they can actually save you tax dollars now too. Therefore it should come as no surprise that IRAs are one of the most universally recommended accounts by financial advisors. However, remember to determine which type of IRA is best for you before opening one. Once open, it should be fairly easy to deposit funds, as you can transfer money from your bank account.

Retirement Planning Tips

  • Opening an IRA is a great step towards getting prepared for retirement. However, you might also benefit from talking to a financial advisor who can help you come up with a complete plan for retirement. Luckily, finding a local financial advisor doesn’t have to be hard. SmartAsset’s free matching tool can pair you with up to three financial advisors in your area. Get started now.
  • Figure out which type of IRA is right for you. With a traditional IRA, contributions are made with pre-tax dollars. This might be good if you expect to be in a lower tax bracket after retirement. A Roth IRA, on the other hand, is funded through after-tax contributions. This makes it a good option if you think your tax rate will go up as you get older.

Photo credit: ©iStock.com/SrdjanPav, ©iStock.com/PeopleImages, ©iStock.com/AndreyPopov

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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