How Much Will a Roth IRA Lower My Taxes?

How Much Will a Roth IRA Lower My Taxes?

Where to Go For Help With Retirement Savings Accounts and Taxes

Retirement and investment income brings special considerations come tax time. Whether you make an appointment with one of our knowledgeable tax pros or choose one of our online tax filing products, you can count on H&R Block to help you get back the most money possible.

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Penalty-Free Early IRA Withdrawals

There are certain situations where you can take an early withdrawal from an IRA without facing a penalty.

You can do so if you are totally or permanently disabled, if you have medical expenses in excess of 7.5 percent of your income or if you need to use the money to pay for health insurance for yourself or your family while you are unemployed. You can also withdraw up to $10,000 for the purchase of your first home or to pay for certain qualifying higher education expenses.

You can also take money out of an IRA without penalty in certain circumstances if you are called to active duty from the military reserves. You also won’t face a tax penalty if the money in your IRA is seized by the IRS to pay a tax bill. Special rules also apply if you inherit an IRA.

Generally, you will still have to pay income tax at your usual rate on what you withdraw from an IRA, even if one of the exceptions apply. You will also have to decide whether it makes more financial sense for you to take money from the IRA or use other savings or a loan to pay whatever expenses are involved.

How to Get an IRA Tax Deduction

Anyone with earned income can open a traditional IRA, contribute the max and benefit from tax-deferred investment growth. But there are strict rules about who’s eligible to reap tax deductions from contributions that can lower your income tax.

Anyone not covered by a workplace defined contribution plan, like a 401(k), can deduct all of their traditional IRA contributions from their taxes. It’s a bit more complicated if you and/or your spouse are covered by a retirement plan at work.

Traditional IRA Tax Deduction Income Limits in 2021 and 2022

Your filing status Your 2021 income Your 2022 income You qualify for:

Single, head of household or qualifying widow(er)

Less than $66,000

Less than $68,000

A full deduction up to the contribution limit

Single, head of household or qualifying widow(er)

$66,000 to $76,000

$68,000 to $78,000

A partial deduction

Single, head of household or qualifying widow(er)

More than $76,000

More than $78,000

No deduction

Married filing jointly or qualifying widow(er)

Less than $105,000

Less than $109,000

A full deduction up to the contribution limit

Married filing jointly or qualifying widow(er)

$105,000 to $125,000

$109,000 to $129,000

A partial deduction

Married filing jointly or qualifying widow(er)

More than $125,000

More than $129,000

No deduction

Married filing separately

Less than $10,000

Less than $10,000

A partial deduction

Married filing separately

More than $10,000

More than $10,000

No deduction

Keep in mind that the limits change slightly if your spouse has access but you do not.

Will you itemize deductions or take the standard deduction?

Beginning in 2018, the standard deduction amount nearly doubled over previous years. At the same time, some itemized deductions were reduced while others were eliminated completely. Many taxpayers are now taking advantage of the standard deduction. To decide if you should claim the standard deduction or itemize, a good starting point is to add up your itemized deductions. If that number is higher than the standard deduction amount, you would itemize. If it’s lower, then you can take advantage of the standard deduction. If you are itemizing your deductions, look for ways to maximize the amount, for example, by increasing your charitable contributions.

How an IRA Works

An IRA is a type of account that you can open for yourself with financial institutions like banks, brokerages and credit unions. Within the IRA, you can invest in a wide range of offerings like stocks, bonds, mutual funds, index funds and, if your institution offers them, banking products like certificates of deposit.

As of 2019, you can contribute up to $6,000 per year to your IRAs, or up to $7,000 if you are 50 or older. This is up from a $5,500 tax break limit for 2018 and earlier years. To reach the IRA tax break limit, you must contribute your own earned income or your spouse’s earned income, so if you earned less than $6,000 in a year, you can only contribute to the extent that you earned.

When you file your taxes, you can claim an IRA tax deduction for your contributions. How much you will save depends on how much you contribute to the plan and what your tax bracket rate is.

When you are over age 59 1/2, you can begin to withdraw money from your IRA without a tax penalty. You will then pay tax on the money you withdraw at your tax rate at the time. If you withdraw money from an IRA before age 59 1/2, you will generally have to pay tax on the funds plus a 10 percent penalty to the Internal Revenue Service unless special limited circumstances apply.

4. Don’t rule out itemizing too quickly

The tax-code changes from the 2017 Tax Cuts and Jobs Act (TCJA) raised the standard deduction while reducing expenses taxpayers can itemize. Despite these changes, itemizing your deductions could still make sense.

One of the biggest deductions, for mortgage interest, is still on the table. If you bought your home after December 15, 2017, you can deduct interest on up to $750,000 of indebtedness. And the limit for homes bought on or before that date is still $1 million. 

You may also be able to deduct a combined total of $10,000 in property tax, state and local income tax, or sales tax paid in 2021. The sales tax deduction applies to all purchases made during the year, including food, clothing, home improvements, or a new car. If you live in a state with no or lower income tax, sales tax might get you a bigger tax break than the state and local tax deduction.

Don’t overlook other opportunities to itemize. For instance, medical expenses that exceed 7.5% of your adjusted gross income (AGI) can be deducted. And under the CARES Act and the Consolidated Appropriations Act, individuals may deduct 100% of AGI on cash donations to qualifying operating charities for 2021.

If you’re a single filer and your deductions exceed $12,550 (or $25,100 for married couples filing jointly), then itemizing would save you more money than the standard deduction. Just be sure to keep receipts for each expense you’re itemizing, and check with an accountant if you’re not sure which costs are deductible.

3. Lower-Income Workers Get an Extra Credit

The Retirement Savings Contributions Credit is another tax incentive that’s geared specifically towards people who don’t earn huge amounts of income. The credit is good for 10%, 20% or 50% of your total IRA contribution up to $2,000, or $4,000 if you’re married and filing jointly. The amount of the credit you qualify for is based on your adjusted gross income (AGI).

For the 2021 tax year, single filers get the 50% credit if their AGI isn’t higher than $19,750. Once your income passes $33,000, you’re no longer eligible for the credit. Married couples can qualify for the 50% credit with a combined income of $39,500 or less. At the $66,000 mark, the credit is phased out entirely. For heads of households, the 50% contribution is attainable with an AGI below $29,625, with a complete phase-out at $49,500.

What is the deadline to contribute?

You can contribute to an IRA at any time during the calendar year and up to tax day of the following calendar year. For example, taxpayers can contribute at any time during 2021 and have until the tax deadline (April 18, 2022) to contribute to an IRA for the 2021 tax year. This means that not only do you have to open the account by this date, you must have funded it, too.

But this long contribution window means that as soon as you have your 2021 contributions settled, you can start contributing for 2022, rather than scrambling at the end of tax season in 2023.

And if you file your taxes before you make your contribution? No big deal. As long as you make your IRA contribution before the tax deadline, you can refile your tax return and still get the tax benefit. It’s a little extra work, but definitely worth the hassle for the savings.

IRA Contribution Limits

The Internal Revenue Service (IRS) places limits on the amount you can invest annually in an IRA, whether you choose to go down the Roth or traditional IRA path. For 2021 and 2022, the IRA limit for contributors is $6,000 plus a $1,000 catch-up contribution for taxpayers who are 50 and over. The contribution maximums apply collectively to all your IRAs, which means they are not per account.

The IRS imposes penalties if you contribute more than the allowable annual amount to an IRA.

Traditional IRA limits

The IRS allows deductions on contributions to a traditional IRA, but the deduction may be reduced or phased out if you (or your spouse, if you file jointly) are covered by a retirement plan at work.

For the 2021 tax year, a single filer covered by a workplace plan can take a full deduction if their AGI is under $66,000 ($68,000 for 2022) or a partial one if they make between $66,000 and $76,000 ($68,000 and $78,000 for 2022). The deduction is eliminated above that amount.

A married couple in which the IRA-contributing spouse is covered by a workplace retirement plan can take a full deduction if their AGI is below $105,000 annually ($109,00 for 2022), a partial one if it's between $105,000 and $125,000 ($109,000 and $129,000 for 2022), and none if their AGI is above that amount. If the other spouse has the workplace plan, the phase-out applies to a joint income between $198,000 and $208,000 ($204,000 and $214,000 for 2022).

Roth IRA limits

Your participation in a workplace plan doesn’t affect your Roth IRA contributions. Your income, on the other hand, does. Specifically, your modified adjusted gross income (MAGI) determines whether or not you can contribute to a Roth IRA and how much you can contribute.

Single taxpayers are good to go until their MAGI hits $125,000 ($129,000 for 2022). If it falls between $125,000 and $140,000 ($129,000 and $144,000 for 2022), they face a gradual reduction of the amount they can contribute. For joint filers, the phase-out applies to incomes between $198,000 to $208,000 ($204,000 to $214,000 for 2022). Exceed those outer limits and you can't fund a Roth IRA at all.

Modified adjusted gross income (MAGI) is your AGI with certain tax deductions added back in, including those for traditional IRA contributions, interest on bonds and student loans, self-employment taxes, and foreign income.

Double Tax Break with the Savers Credit

Some low- and moderate-income taxpayers get an extra tax break on their 2021 return for contributing to an IRA or other retirement account.

In addition to the usual IRA deduction, you may qualify for a Retirement Savers tax credit of up to $1,000 ($2,000 for joint filers) for contributions to an IRA or other retirement tax plan. (A tax credit, which reduces your tax bill dollar-for-dollar, is more valuable than a deduction, which merely reduces the amount of income that is taxed.)

Comparing tax savings: Traditional IRA vs. Roth IRA

If you’re looking for last-minute tax savings this year, you’ll want to make sure that you select the right IRA – the traditional IRA. But you should watch out because there’s another kind – the Roth IRA – that gets you tax savings in the future, rather than today.

The traditional IRA offers you a tax break today in exchange for allowing your investments to grow tax-free until retirement. When you withdraw your money in the future, you’ll pay taxes on the distributions.

In contrast, the Roth IRA gives you a future tax break because you’re saving with after-tax money today. With the Roth IRA, your investments grow tax-free and you won’t pay any taxes on qualified withdrawals later.

While these are the most substantial differences between the two IRAs, there are further differences that you’ll want to understand before making a final choice.

Understand required minimum distributions

As of January 1, 2020, the age to start withdrawing the minimum amount from your retirement accounts was changed to 72 for those who will reach age 70 1/2 after 2019. Make sure that you have a plan in place and actually start taking your required minimum distributions (RMDs). If you miss an RMD or forget to take them, you could face severe income tax penalties (up to 50% of the RMD amount). For more information, visit our RMD Rules page.

Together with your tax advisor, a TIAA financial professional can help you understand the distribution requirements and see how your required minimum distribution strategy fits into your broader retirement planning.

1. Consider contributing to a traditional IRA

One way to potentially save on your 2021 taxes and put away money for later is to contribute to a traditional individual retirement account (IRA).

If you qualify, these accounts can give you upfront tax deductibility on your contributions, plus tax-deferred growth of your earnings. For 2021, you can contribute up to $6,000 to a traditional IRA (plus a $1,000 catch-up if you’re age 50 and over), and you have until Tax Day to do so.

Because contributions to a traditional IRA reduce your taxable income dollar for dollar, they could be enough to drop you into a lower tax bracket. Given that some gaps between tax brackets are quite large—for instance, the drop from 22% to 12%—those savings can be significant.

Contributing to a Roth IRA, on the other hand, won’t lower your taxable income today. But it might help you save on taxes in retirement, depending on your goals. “In some cases, a Roth may make more sense than a traditional IRA,” Hayden explains, “for example, if you’re in a low tax bracket today but expect to be in a higher tax bracket when you withdraw the money.”

Get that Last-Minute Deduction

Don't fret if it’s late in the calendar year, and you haven’t yet contributed to an IRA. You're permitted to contribute up until Tax Day of the following year. It will still count toward the previous year. That means for the 2021 tax contributions can be made till April 18, 2022.

There are different types of individual retirement accounts such as traditional IRAs and Roth IRAs that can help you with tax planning.Total contribution limit for all IRAs combined is $6,000, ($7,000 if you’re over 50 years of age) in 2021 and 2022. IRS also sets income-based limits to determine how much you can deduct from traditional IRAs and contribute into Roth IRAs.You invest pre-tax money into a traditional IRA, and pay tax, hopefully at a lower rate, when you take a distribution in retirement.Investment in Roth IRAs is after-tax dollars, but the benefit is that you don’t pay taxes when you take the distribution. The Roth IRA investment is not deductible.IRA contributions for a tax year must be made by the Tax Day in the following year.

Roth IRAs: Tax Savings in the Future

A Roth IRA is something like a traditional IRA in reverse since contributions consist of after-tax dollars, unlike with a traditional IRA. The key feature of a Roth IRA is that investment gains can be withdrawn in retirement completely tax-free.

Since you're contributing after-tax dollars into a Roth IRA, those contributions are not deductible.

As with traditional IRAs there are income thresholds and limits that determine if and how much money you are able to contribute into a Roth IRA.

Eligibility breaks down like this for 2021 and 2022:

  • Maximum Contribution:Single filers with MAGI lower than $125,000 in 2021 and $129,000 in 2022 will be able to utilize the entire contribution limit for Roth IRAs. That threshold is earnings less than $198,000 for married filers filing jointly in 2021 and less than $204,000 in 2022.
  • Limited Contribution: Single filers with MAGI greater than $125,000 but less than $140,000 in 2021 and greater than $129,000 but less than $144,000 in 2022 are allowed limited contributions into Roth IRAs. For married filing jointly in 2021, the MAGI range is greater than $198,000 and less than $208,000 (more than $204,000 and less than $214,000 for 2022). For married filing separately, limited contribution is allowed for MAGI up to $10,000 in both 2021 and 2022.
  • No Contribution: Single filers with MAGI more than $140,000 in 2021 ($144,000 in 2022) and joint filers of married returns earning $208,000 or more in 2021 ($214,000 or more in 2022) aren't permitted to contribute to a Roth IRA. This drops to just $10,000 if you're married and file a separate return.

The Bottom Line

Individual retirement accounts are a great way to reduce your tax liability. But keep in mind, there are restrictions on which accounts you can own and how much you can contribute. You can also look at other options to reduce your taxable income, including HSAs and FSAs. When in doubt, always check with a financial professional in order to avoid making any mistakes.

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