It’s a new year, and the book has closed on 2022. But, those still looking for a way to reduce their 2022 tax bill and accelerate their retirement savings have a planning opportunity available, which is to make an individual retirement account (IRA) contribution before the tax filing deadline of April 18, 2023.
Reduce Your Tax Bill
Unlike most other tax deductions, which must be recorded before the end of the calendar year, the IRS allows tax-deductible IRA contributions to be made up until the tax filing deadline. Those eligible can contribute up to $6,000 or $7,000 for those 50 or older (contributions limits increase to $6,500 and $7,500 for the 2023 tax year).
As you or your preparer work on your tax return, you can plug in an IRA contribution to see exactly how much your tax bill will decline. For eligible taxpayers, contributions to a traditional IRA can be deducted from your taxable income, resulting in immediate tax savings. For example, if you are in the 24 percent tax bracket, a $6,000 contribution will reduce your taxable income by the same amount, resulting in a tax savings of $1,140 ($6,000 x 24 percent).
Beware of IRA Income Limits
Anyone can contribute to an IRA, even if they participate in an employer-sponsored retirement plan. The issue is whether you’re eligible to deduct the full amount of your contribution or not.
If you and your spouse don’t have access to a workplace retirement plan, you can deduct the full amount of your traditional IRA contribution.
If you and your spouse have access to a workplace retirement plan, the deductibility of your contribution is phased out above certain income levels. For example, single filers may take the full deduction if their income is $68,000 or less. For incomes between $68,000 and $78,000, the deduction is phased out and unavailable for incomes of $78,000 or more. For married filers, the income threshold is $109,000 to $129,000. (IRA income thresholds are increased in 2023).
If only you or your spouse has access to a workplace retirement plan, the income limits increase to $204,000 to $214,000 for 2022.
Compare the Advantages of a Traditional and Roth IRA
While using an IRA tax deduction to reduce your tax bill is appealing, you may want to compare the advantages of a traditional IRA vs. a Roth IRA. If your taxable income places you in a lower tax bracket in 2022, contributing to a Roth IRA may make more sense. You won’t get a tax deduction, but unlike a traditional IRA, the earnings in a Roth are not taxed when you withdraw them. Depending on your circumstances, a Roth IRA could generate more after-tax cash flow in retirement. If you earn less than $144,000 as a single filer or $214,000 as joint filers, you are eligible to contribute to a Roth IRA for 2022.
Make Sure You Apply Your IRA Contribution to the Correct Year
It’s not uncommon for people to make an IRA contribution for the prior year but accidentally apply it to the current year. When you make an IRA contribution, you are asked by the IRA provider if you want to use it for the prior year or the current year. If you check the wrong box, you will not receive the tax deduction for 2022. If that does happen, you can go to your IRA custodian and complete a form to reclassify for the prior year.
Is a Last-Minute 2022 IRA Contribution Right for You?
All major money moves have consequences. What’s right for one investor may not be ideal for another. Accordingly, your decision to make a last-minute traditional IRA or Roth IRA contribution will have tax and retirement planning implications that should be discussed with your advisors.
Don’t have a retirement plan yet? Not confident in your current retirement plan? Or simply need a retirement plan check-up? No matter where you are in your retirement planning journey, our team can help. Simply schedule an appointment with one of our trusted advisors to discuss your opportunities today.
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