When you save for retirement, it is always wise to invest in a tax-protected account, such as an Individual Retirement Account (IRA) or a 401(k) plan. These accounts allow you to reduce the taxes you will pay on your income, increasing the amount you will keep for retirement.
Traditional IRA: Tax Savings Upfront
You can contribute up to $6,000 in total across all your traditional IRAs and Roth IRAs annually in 2022, and $7,000 if you’re age 50 or older, with these limits increasing by $500 in 2023. Your contributions can be deducted from your taxable income.
Roth IRA: Tax Savings in the Future
A Roth IRA is similar to a traditional IRA, with the difference being that contributions consist of dollars that have been taxed upfront, unlike the traditional IRA. The main advantage of a Roth IRA is that investment gains can be withdrawn in retirement completely tax-free.
Which IRA Should You Choose?
The good news is that you don’t have to choose between a traditional IRA and a Roth IRA. There is no rule stating you cannot contribute to both, but the allowable limits apply to them combined, not individually. It can be difficult to predict your income and tax bracket at retirement, so it often makes sense to put money into both types of accounts to benefit from tax advantages regardless of the method – upfront with the traditional IRA that provides tax deductions, or in the future with the Roth IRA that allows tax-free withdrawals.
Get a Last-Minute Tax Deduction
Don’t worry if the year has ended and you haven’t contributed to an IRA yet. You are allowed to contribute until the tax day of the following year. The contribution will count for the previous year. This means you can make contributions for 2022 up until the tax return deadline in 2023.
Frequently Asked Questions
How much does an IRA save in taxes? If you meet the eligibility criteria and are able to contribute the maximum contribution of $6,000 to a traditional IRA in 2022, you will save paying taxes on that amount now. The idea is that your tax bracket in retirement might be lower, and you will be taxed at a lower rate on that money and any gains it earns when you withdraw it. For the Roth IRA, while you are contributing dollars that have been taxed upfront, you will not be required to pay taxes when you meet certain criteria.
Who should open an IRA to save on taxes? Generally, anyone who can report income can invest in a traditional IRA. However, there are restrictions on its tax effectiveness based on your income and marital status. According to the IRS, “the deduction for a traditional IRA contribution may be limited if you or your spouse are covered by a retirement plan at work and your income exceeds certain levels.”
Source: https://www.thebalancemoney.com/will-opening-an-ira-help-you-save-money-on-taxes-4582437
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