Want to reduce your 2023 income taxes ahead of the April 15 deadline?
There’s still an opportunity for many to contribute to a Traditional Individual Retirement Account (IRA) and claim a higher deduction.
This is one of the few actions you can take post-year-end to lower last year’s tax bill, and thankfully, it’s straightforward. Money placed in a Traditional IRA can be deducted from your taxable income, thereby reducing the overall amount of income tax you owe for 2023. This simple strategy allows you to keep more of your money by diverting a portion of your taxable income to a Traditional IRA instead of paying that portion in taxes.
The critical deadline to keep in mind is April 15, 2024, the same day your taxes are due.
Note that not everyone can use this tax-saving strategy. Your ability to deduct IRA contributions on your tax return depends on various factors, including your income, whether you or your spouse are covered by a retirement plan at work, and your filing status.
For 2023, the IRA contribution limits are $6,500 for individuals under 50 and $7,500 for those aged 50 and above. These contributions must be made in cash (including checks) and cannot be in the form of securities or assets. However, the potential tax savings make exploring this option well worth it.
Who Can Benefit from Contributing to a Traditional IRA?
If you’re not covered by a workplace retirement plan, you can typically deduct the full amount of your IRA contribution, regardless of income. However, if you or your spouse have a retirement plan at work, the deduction may be limited based on your modified adjusted gross income (MAGI).
For those who qualify, the tax savings can be significant. For example, if you’re in the 22% tax bracket and can contribute and deduct the full $6,000, you could save $1,320 in taxes. Not a small sum for a simple contribution.
Steps to Making Your IRA Contribution
- Choose an IRA Custodian: This could be a bank, brokerage, or a self-directed custodian like Horizon Trust.
- Open a Traditional IRA Account: Ensure it’s designated for the 2023 tax year.
- Make Your Contribution: Do this before April 15, 2024, to count it towards your 2023 taxes.
- File Your Taxes: Deduct your contribution when filing your 2023 tax return.
- If self-directed, invest in tax-deferred investments like cryptocurrency, gold and other precious metals, stocks, real estate, or others not available within a standard IRA.
By contributing to a Traditional IRA, you not only save on taxes for the previous year but also invest in your future. The funds in your IRA will grow tax-deferred until you withdraw them in retirement, offering a dual benefit of immediate tax relief and long-term financial growth.
How About a Roth IRA vs. a Traditional IRA? What’s the Difference Again?
The Traditional IRA is often hailed for its immediate tax relief, making it an attractive option for those seeking to reduce their taxable income in the current year. Contributions to a Traditional IRA may be fully or partially deductible, depending on your income, filing status, and whether a retirement plan at work covers you or your spouse. This means you can see a reduction in your tax bill now, with the trade-off being that distributions in retirement are taxed as ordinary income.
On the other hand, the Roth IRA contributions are made with after-tax dollars, which means there’s no immediate tax deduction. However, when withdrawals are entirely tax-free, the trade-off comes in retirement, provided certain conditions are met. This can be a significant advantage for those who anticipate being in a higher tax bracket in the future or for those who value tax-free income in retirement for financial planning purposes.
One key distinction to note is the eligibility criteria for both IRAs. Traditional IRAs allow contributions regardless of how much you earn. Still, the deductibility of these contributions may be phased out based on income levels if you or your spouse have access to a workplace retirement plan. Conversely, Roth IRAs impose income limits on who can contribute, making them inaccessible to high earners directly. Take note that the IRS allows high-income owners to convert all or a portion of funds from a Traditional IRA into a Roth IRA as a taxable event. Make sure to consult your tax advisor if you have questions.
Moreover, the Roth IRA offers more flexibility with its withdrawal rules. Contributions (but not earnings) can be withdrawn at any time without penalty, offering a form of financial backup that’s not as readily available with a Traditional IRA. Additionally, Roth IRAs do not require minimum distributions at age 73, unlike Traditional IRAs, allowing for longer tax-free growth and estate planning advantages [Learn more: How to Maximize Roth IRA Contributions].
Understanding these nuances is critical in making an informed decision. For those in a higher tax bracket today who anticipate being in a lower tax bracket in retirement, a Traditional IRA may offer the most benefit. Conversely, the Roth IRA’s tax-free withdrawals can provide significant savings for younger investors or those expecting to be in a higher tax bracket in the future.
Reduce your Taxes Today
Although 2023 is behind us, the opportunity to reduce your tax bill is still very much alive until April 15, 2024. Contributing to a Traditional IRA can offer a sizable deduction, leading to significant tax savings.
It’s a reminder that it’s never too late to take action on last year’s taxes and simultaneously bolster your retirement savings. As always, consult with a tax professional to understand how this strategy fits into your overall financial plan.
Don’t let the chance to save on your taxes slip by as the deadline approaches. Opening or contributing to a Traditional IRA is a smart move for both your current and future financial well-being.
