The best thing about tax season is the anticipation of receiving a refund — the bigger the better. And this year, more than half of all taxpayers plan to use their refund to improve their finances by paying off debt or building their savings.
What many people don’t realize is that there may be a way to boost your tax refund while also saving for retirement. The secret? Contribute to a traditional individual retirement account (IRA).
A traditional IRA could be the perfect tool for investing in your future retirement while enjoying tax advantages today. With a traditional IRA, your contributions may be tax-deductible now, which means you won’t have to pay taxes on the money until you start making withdrawals. And here’s the best part: Even if you’ve never contributed to an IRA, you may be able to get a bigger tax refund this year if you open one right now.
How does it work?
Contributing to an IRA can minimize your taxable income, and you have until the April 15 filing deadline to open one and make a contribution for the 2018 tax year. Reducing your taxable income increases your chances for a larger refund. According to TurboTax, contributing to an IRA “gives you the flexibility of claiming the credit on your return.”
There are a couple of things to keep in mind, however.
First, your contributions typically are fully tax-deductible as long as you don’t have access to an employer-sponsored retirement plan. If you already have a 401(k) or 403(b) and your income exceeds a certain threshold – this year it’s $73,000 for a single filer or $121,000 for a joint married filer – you may not be eligible to deduct all of your IRA contributions. So, it’s important to consult a tax professional before going ahead with this strategy.
Additionally, not every IRA offers this tax benefit. A Roth IRA is taxed differently than a traditional IRA. Instead of deducting your contributions now, you pay taxes on the income as usual but get to make tax-free withdrawals later. So, if you want to use retirement savings to reduce your tax liability today, make sure you’re opening a traditional IRA and not a Roth IRA.
How much can I contribute?
While there’s often no minimum contribution required to open a traditional IRA, there is a cap on how much you can contribute each year. For the 2018 tax year, you can contribute up to $5500 if you’re under 50 and $6500 if you’re 50 or older (if eligible).
That limit increases in 2019, allowing you to contribute up to $6000 if you’re under 50 and $7000 if you’re 50 or older and eligible — so keep that in mind for next tax season.
What are the other benefits of a traditional IRA?
Tax advantages aside, one of the biggest benefits of a traditional IRA is the ability to use compound interest to help your retirement savings grow faster. How? When you contribute to an IRA, you earn interest on your funds. That interest gets added to your account balance, and you start earning interest on your interest as well as on the principal. Each time you earn interest, the balance grows — and so does the amount of interest you earn. Over time, compound interest makes a big difference in your retirement savings.
What’s the next step?
If you’re interested in opening a traditional IRA before Tax Day, contact OCCU to speak with an IRA specialist. We’ll talk you through the process and help you decide if a traditional IRA is the right option for you.
As financially responsible adults, we often have to choose between what’s helpful in the short term and what will benefit us most in the long term. With a traditional IRA, you may be able to do both at the same time.