Get the rundown on IRA’s just in time to still be eligible for the 2019 tax deduction.
The Basics of Tax Deductions
Every year, the dreaded tax season arrives without fail, and many Americans often find that they would rather be doing ANYTHING else. So it’s not unusual that eyes tend to glaze over on the details surrounding deductions, credits, exemptions and what makes you eligible for these benefits.
Citizens are required to pay taxes based on their taxable income, which includes wages, salaries, bonuses, tips and investment incomes. Deductions and exemptions both reduce your taxable income, however, the new tax law in 2018 removed tax exemptions. Tax “credit” is often used interchangeably with “deduction”, however, credits directly reduce the dollar amount of owed taxes, rather than your taxable income.
In the US, most individuals are prone to choosing a standard federal deduction that fluctuates by year and taxpayer information. Each state sets a precedent for state tax and primarily offers a standard deduction on the state level. Taxpayers have the option to take the standard deduction amount or to itemize deductions. Deductions lower a person’s tax liability by lowering your taxable income, like interest paid on student loans or deposits into a traditional IRA. You can take advantage of a tax deduction from IRA contributions through a standard deduction or by itemizing your deductions.
Types of IRA’s
An Individual Retirement Account (IRA) is a special tax-advantaged account used for saving retirement funds. These accounts are long-term savings that earn dividends and often have penalties for withdrawing early. The tax benefits of each IRA is the major difference between them. Both of the common IRA accounts, traditional and Roth, have a cap on the amount you can contribute each year.
A traditional IRA allows eligible taxpayers to receive a tax deduction at the time of deposit. All your contributions for the year are totaled and your taxable income for the year is reduced by this number. This means when tax season is upon us, you could have a smaller tax bill. Your account then earns dividends tax-deferred. However, when the time comes to withdraw your money, you will then have to pay the income tax. Anyone can open and contribute to a traditional IRA, regardless of income.
A Roth IRA does not allow for tax deductions when you make contributions. However, your money still grows tax-deferred. The pro of this account is that you can withdraw your money tax-free when you retire. However, wage earners will not be eligible for a Roth IRA if their income is too high. Though less common, there are many other types of IRAs. Be sure to ask an expert which IRA is best for you.
Do I Need an IRA now?
Any time is a good time to save for your retirement. You may be reading this with the thought “I’m too young to think about retirement.” However, the sooner you invest in your retirement, the more you will earn through compound interest. So investing $5,000 at 25 without early withdrawals would yield more money than if you were to invest $20,000 at 45 years old.
On the flip side, you’re probably not too old to fund an IRA either. In 2020, the maximum age restriction for contributing to an IRA was eliminated. Your only stipulation is that you must be generating income still to contribute. However, the options really expand with a Roth or spousal IRA.
Am I Eligible for a Tax Deduction on an IRA?
Anyone who makes any income level can invest in their traditional IRA, however, you have a limit to how much you can contribute yearly. There is also a limit on how much of your contribution can be deducted from your taxes. If you or your spouse has a retirement plan at work, you may be subject to only a partial deduction, or no deduction at all if your adjusted income exceeds annual limits. When doing your taxes, either talk with a professional or look for an IRS-provided worksheet to determine your deduction value.