People are starting to get tax documents in the mail for 2012 right now. And one of the easiest deductions for qualified taxpayers is a contribution to an IRA or individual retirement account.
This is a great move for many Americans for four main reasons:
It Can Substantially Reduce Your Taxable Income: The limit is a $5,000 contribution to an IRA — or up to $6,000 if you’re 50 or older. That’s a big chunk of change to take out of your tax burden.
If You Have No 401k, You Desperately Need to Start Planning: The vast majority of Americans are dramatically behind schedule on their retirement planning. Nearly half of Americans aren’t saving a penny for retirement according to recent surveys. If that describes you, the tax write-off is nice but the ability to actually pay the bills when you’re in your 80s is an even bigger benefit.
IRAs are Flexible: With IRAs you can choose from a much wider array of investments via ETFs and even individual stocks. True, a lot of folks aren’t sophisticated enough to gamble on stock picking. But in vehicles like a 401k, you often are roped into a small group of funds and can’t shop around to keep your fees low — a simple but crucial part of any successful retirement strategy.
You Still Have Time: You can make your IRA contribution right up until tax day in April. Even if you missed certain tax moves in 2012 like donating to charity, you can take the IRA on your 2012 returns any time before the final filing deadline. Tax day is April 15, 2013, so there’s no rush.
If you currently have no retirement plan, this is a no-brainer. Single and head of household filers have no income limit if an IRA is their only retirement vehicle, and neither do married couples filing jointly — presuming neither spouse has an employee-sponsored plan.
Who Misses Out on the Tax Break?
However, there are a few specific instances when an IRA doesn’t make sense … at least from a tax deduction perspective.
Married, Filing Separately: The first group who may not benefit are married folks filing separately. The IRS only offers a partial deduction — and then only if you file less than $10,000 in adjusted gross income. That’s a pretty low ceiling.
Married, Making Over $173,000: High-earning families also may find no tax benefit from an IRA contribution. Married couples filing jointly can take the $5,000 deduction if they make under $173,000 total and a partial deduction if they make $173,000 to $183,000. But bring in more than $183,000 for your household and you’re out of luck.
Those Participating in an Employee-Sponsored Retirement Plan: If you have a 401k through work, the IRS isn’t interested in giving you a tax break to entice you to save … because you’re doing it already. Thus the gross income threshold is significantly lower for folks with an employee-sponsored retirement plan. Single folks making over $68,000 get no deduction, and married couples filing jointly who make over $112,000 get no deduction either.
Check out the IRS website for specifics on deductions. Those with a retirement plan at work can find details here, and those without an employee-sponsored plan can find deduction limits here.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks.