How to Use a Traditional IRA as a Last Minute Tax Break

by Kevin on March 31, 2011

The tax filing deadline for 2010 isn’t April 15th — this year it is April 18th. You’ve got 18 more days to file your taxes. 18 more days to squeeze every last drop of tax benefit out ┬ábefore you file. If you are looking for a last minute tax break consider a Traditional IRA. Getting a tax break and setting yourself up for a successful financial future at the same time? Sounds like a winner to me.

Why a Traditional IRA Saves You Taxes

I’m a big fan of Roth IRAs. I would much rather pay taxes now and watch my investments grow tax free to my retirement.

However, you can make the case for using a Traditional IRA today rather than a Roth. If you anticipate your tax rate being lower in retirement than it is now then choosing a Traditional IRA is the best choice. A Traditional IRA is a tax-deferred investment. This means you get a tax break today on the money you invest, and you pay taxes on that money (plus any growth) in the future. If you think your tax rate will be lower when you retire then you’ll pay the lower tax rate then rather than a higher tax rate now.

You can use a Traditional IRA right before filing taxes in a strategic manner. Let’s say you are single and make enough money to land at the front portion of the 28% tax bracket. The tax bracket begins at $82,400 and last year you earned $84,000. You haven’t filed your taxes, but would love to drop out of the higher marginal tax bracket. By investing the full contribution limit (this year it is $5,000) into a Traditional IRA you would drop your taxable income from $84,000 to $79,000. This would drop you out of the 28% marginal tax bracket and back into the 25% tax bracket. Your tax savings would be $1,298! You would save $448 from $84,000 to $82,400 ($1,600 x 0.28 = $448) and $850 from $82,400 to $79,000 ($3,400 x 0.25% = $850).

You Have Time to Invest for Last Year

Even though the last tax year ended months ago you still have time to invest in an IRA (Traditional or Roth). You have until the tax filing deadline to invest in an IRA. So get going! If you don’t invest by the tax filing deadline you can’t go back and try to invest for the previous year. This is a limited time opportunity to secure your financial future.

How Much Can a Traditional IRA Save You?

For singles investing the maximum $5,000 in a Traditional IRA:

Tax RateMaximum Savings
15%$750
25%$1,250
28%$1,400
33%$1,650
35%$1,750

For married filing joint (each investing the maximum $5,000 for a total of $10,000):

Tax RateMaximum Savings
15%$1,500
25%$2,500
28%$2,800
33%$3,300
35%$3,500

One Reason You Shouldn’t Rush to Invest

While you don’t have much time to invest, don’t make a rushed decision. Only invest money that you can afford to not touch until retirement. With a Roth IRA you can withdraw your contributions at any time without a tax penalty or early withdrawal penalty. This is not true with a Traditional IRA — your contributions will be taxed at your current income rate plus a 10% early withdrawal fee. Make sure you can afford to wait to see the money until retirement.

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