One of the biggest benefits of opening an IRA prior to tax season is the ability to lower tax liability for the prior tax year. That’s because these contributions can be deducted from last year’s taxes all the way up until April 18. Because of this factor, many IRA holders rush to contribute during the month before the April 18 cutoff. It is said that investment companies receive about 45 percent of the IRA contributions during this time.
How Much Can Taxes Be Lowered by Contributing During Tax Season?
When a traditional IRA is used and if you make a contribution that qualifies as deductible, the contribution amount is deducted from your adjusted gross income. Taxes aren’t paid on IRA funds until they are withdrawn. With IRAs, the money is intended to remain in the fund until retirement, and penalties for early withdrawal are substantial.
The limit on IRA contributions is $6,000 per person for the 2021 tax year for most people. For those age 50 or over, the limit jumps to $7,000. This means that everyone who is eligible can reduce their adjusted gross income by $6,000 by contributing up to the limit.
Extra tax breaks exist for people who have lower incomes. These breaks reach up to $1,000 for singles and $2,000 for married couples. This break takes the form of a federal tax credit called the retirement savings credit. Unlike deductions, tax credits are directly applied to tax liability just like regular tax payments would be. This means that eligible filers can even end up getting a refund thanks to this credit.
Eligibility for these credits depends on income, and the cutoff increases every year. Check with a tax professional or financial adviser to learn the current limits.
The biggest immediate tax benefits are obtained by those who make the maximum contribution to a traditional IRA and qualify for the full tax credit. For those who would rather lower their tax liability at retirement time, a Roth IRA should be considered. With a Roth IRA, taxes are paid during the contribution year but aren’t charged at the time of retirement.
Ensuring Proper Credit for Contributions Made Early in the Year
When contributions are made between January 1 and April 18, it’s important to tell the financial institution which year to apply the contributions. This is because contributions made during this time can legally be applied either to the prior tax year or the current one. If the goal is to cut taxes this year, be sure that the contribution is credited to last year’s IRA cycle.
The practice of contributing to IRAs during tax season exists because of the April 18 cutoff date. This date sets IRAs apart from other financial instruments, which have December 31 as their cutoffs. By keeping it in mind, investors can keep more money in their portfolios even after the first of the year.
When trading options in an IRA, there are significant limitations as to how potential losses can be covered.
eOption IRAs incur an annual fee of $15.00. A Closing Fee of $50.00 will apply to Total Distributions, and an ACAT Transfer Fee of $60.00 may apply.