There are many good reasons to save for retirement. You can give your money time to grow, and you can feel certain that you’ll be able to care for yourself financially when you’re older. But there’s another good reason to put money away: tax benefits.
If you contribute to a traditional IRA, you reduce the amount of money you pay in taxes for that year. Traditional IRA contributions are an adjustment to your gross income — they’re not counted as part of your taxable income for the year, regardless of whether you itemize your deductions or take the standard deduction.
You pay taxes on your traditional IRA savings and earnings only when you take distributions from your account in retirement. So if you put savings away in a traditional IRA account for 10, 20, or even 30 years, your earnings can continue to grow free from taxes as long as they remain in the account. This is unlike a standard savings or investment account, in which you pay taxes on earned income every year. In a traditional IRA account, you can hold on to your earnings and gains for a longer period, and use them to generate more income and capital gains.
Once you do retire, you may no longer need income to cover mortgage payments or similar expenses, so you may take smaller distributions from your retirement accounts. If this places you in a lower tax bracket, you’ll pay less in taxes than you did when you were earning money.
Saving for retirement is very smart. It just takes some planning to get started and take advantage of those tax benefits.
Learn what you can contribute. There are limits to what you can contribute every year. In 2011 and 2012, if you are under 50 years old, you can contribute $5,000 to a traditional IRA, a Roth IRA or a combination of both. In 2011 and 2012, if you are 50 years old or older, you can contribute a maximum of $6,000 to these accounts. (You must be under 70 to contribute to a traditional IRA.) To make contributions to these IRA accounts, you need to have earned taxable compensation (i.e. wages, salaries, commissions, etc.) during the year.
If you earned less than these maximums, you can only contribute up to the amount that you earned. Roth IRA contributions are subject to income limits.
Learn what you can deduct. The amount you can deduct depends on your adjusted gross income, filing status, and whether or not you or your spouse are covered by a retirement plan at work.
You can talk to a tax professional or find the IRA deduction charts online at irs.gov. Only traditional IRAs are deductible. Roth IRAs are not deductible, but they have other tax benefits that we’ll discuss in later columns.
Contribute for 2011. If you haven’t met the maximum for 2011, there’s still time! You have from Jan. 1, 2011 to April 17, 2012 (this year’s tax deadline) to contribute to a traditional IRA, in order to take the deduction for 2011 and lower your tax bill.
Start planning for 2012. You can find room in your budget for retirement savings going forward, and make contributions every month to steadily build those savings and take advantage of IRA tax benefits. You’ll reap rewards for doing so now and in retirement.
Michael Camacho is president and chief executive officer of Personal Finance Center. He has more than 19 years experience in retail banking and with financial institutions in Guam and Hawaii. You can email him at firstname.lastname@example.org.