Save on taxes while saving for retirement with the IRA tax deduction!
Having a comfortable retirement should be something anybody with foresight should goal for. Even the government thinks so. They offer tax breaks and credits, just to help us save money for retirement.
Now most people don't think ahead. I'll start saving tomorrow, next year, just not today! But with tax savings dangling in front of you, it makes it easier to put away the money for retirement.
So what is the IRA tax deduction?
It's a way to save money on your tax return by putting away money in a special investment account called Individual Retirement Account (IRA). Now, there are many different IRA's but we will now discuss the Traditional IRA, since this is the one that you get to deduct the contributions on your tax return as an IRA tax deduction.
So it works like this:
Generally, when you receive a distribution from a traditional IRA (other IRAs are different) you must pay tax on the whole amount that you receive.
So in reality you are paying taxes on your IRA contributions. Just what exactly do you gain? Instead of paying the taxes now, you are pushing it off to pay later when you retire and then your tax bracket might be lower.
Your IRA tax deduction can be up to $5000 ($6000 is you are over fifty). This amount is separate for each spouse. So if you are married filing jointly the deduction can be as high as $10,000 (or $12,000 if both are over 50 years).
Here are some limits to your IRA contribution:
You can contribute any time starting from the beginning of the tax year that the IRA tax deduction is taken until the due date of that tax return. This allows you to make the IRA contributions after the tax year is over and you know exactly what your tax situation is.
The year you turn 70 1/2 years you have to stop making contributions.
Where can you open you IRA?
Many financial institutions, banks, mutual fund companies, life insurance companies, and stockbrokers offer IRA accounts. When opening the account you will need to specify which type of IRA you want.
Before choosing where to make your IRA make sure to check references.
When can you receive distributions?
You can receive distributions at any time but if you get a distribution before you are 59 1/2 years old you will have to pay a penalty of 10%. This is besides the taxes for the distribution.
There are exceptions for penalty on distributions taken before age 59 1/2 for:
Between 59 1/2 years and 70 1/2 years of age you can receive distributions however you please.
Once you turn 70 1/2 you must start taking distributions. Beneficiaries also have to receive distributions every year. A surviving spouse can choose to be treated as the owner and can wait with the mandatory distributions until the age of 70 1/2.
Not making the correct distributions will lead to paying an excise tax of 50% for the undistributed amount.
How do you know how much your distribution must be?
The IRS has charts which helps you calculate the correct distribution amount. There are different charts for owners, beneficiaries, owners whose spouse is the only beneficiary and is ten years younger than the owner.
These charts are designed according to life expectancy.
Updated December 12, 2012
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