4 Ways to Lower Your Tax Bill With an IRA

Putting money in an IRA can mean a tax deduction. Using the IRA to give to charity or trade stocks can save, too.
Feb 16, 2018
4 Ways to Lower Your Tax Bill with an IRA

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Individual retirement accounts are popular ways to sock away money for the future, but IRAs also come with some benefits that can lower your tax bill.

First, some IRA basics

There are two kinds of IRAs: traditional and Roth. Each allows an individual to contribute up to $5,500 a year, on top of what you can contribute to a 401(k) or other employer-sponsored retirement plan. Those 50 and older can put in an extra $1,000 a year as a catch-up contribution. Eligibility to contribute to a Roth IRA is based on income, but anyone can contribute to a traditional IRA.

How to cut your tax bill with an IRA

1. Put money in the account

The money you contribute to a traditional IRA may be tax-deductible. That’s great if you’ll be in a lower tax bracket in retirement than you are now because you’ll get the tax break up front when it benefits you the most. There are a few catches, though: The amount you can deduct may be limited by your income and whether you or your spouse has access to a retirement plan at work. Read this guide to help determine if that’s an issue for you.

The money you put in a Roth IRA, on the other hand, isn’t tax deductible now — but your withdrawals generally aren’t taxed at all. That’s good if you’re in a lower tax bracket now than you expect to be in the future, when you’ll benefit most from the tax break.

IRAs are good for socking away money for the future, but they also can help lower your tax bill.

You have until the April 17, 2018, tax deadline to make IRA contributions for the 2017 tax year. The deadline for contributing to the other tax-slashing retirement savings account — the 401(k) — ends with the calendar year. So if you’re preparing your 2017 tax return but haven’t made a contribution (or haven’t made the maximum contribution) yet, run the numbers and see what it could save you, says Bobby Medlin, a certified public accountant in Tipton, Missouri.

See more ways to save and invest for the future

2. Give away some of it

In general, you have to start taking required minimum distributions from a traditional IRA the year you hit age 70½. But if you don’t need the cash, you can donate it and get a tax break.

There are two ways to do this. In the first, you withdraw the money, put it in your bank account, then give it to the charity. You'll have to report the money as income because you touched it, even if just for a moment, but you get to deduct your donation. Just remember that to deduct, you’ll have to itemize on your tax return.

In the second method, you donate up to $100,000 a year directly from your IRA. Because the money never goes to you, you can't deduct the donation, but you also don’t have to report the money as income. That could be a big deal if you’re getting Social Security, Medlin says.

“If you have too much other income, there's a formula that starts making your Social Security benefit taxable,” he says. “Well, this required minimum distribution from your IRA, if it's not hitting your tax return because you directed it to a charity directly, it doesn't count in that calculation.”

3. Make your stock trades inside the account

“If I was playing the stock market a little bit, I might want to do that with my IRA account,” says Steven Weil, an enrolled agent at RMS Accounting in Fort Lauderdale, Florida. Capital gains inside a traditional IRA are tax-deferred, and tax-free if you have a Roth IRA; capital gains in a regular brokerage account typically aren’t, he says.

“For example, if I've got investments in my IRA and I have investments that are not in my IRA, well, I don't want to do all of my stock trading and have to report the gains, especially if they're short-term gains. I'm better off to do that in my IRA account,” he says.

4. Go in through a back door

You can convert a traditional IRA into a Roth IRA so that withdrawals in retirement are tax-free. But remember, only post-tax dollars get to go into Roth IRAs. So if you deducted traditional IRA contributions on your taxes, then decide to convert this to a Roth (here’s how to do it), you’ll need to pay taxes on the money you contributed, just like everyone else who invests in a Roth IRA. For this reason, backdoor Roths generally work better for people who will be in a higher tax bracket in retirement than they are now.

Even though you may have to pay extra taxes this year, the long-term tax savings could be huge.

“Ten years from now, let's assume my Roth grows and the $5,500 I contributed is worth $11,000. Assuming I'm over 59½, I can take the $11,000, zero tax,” Weil says.

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