Tax benefits of an IRA
If you make contributions to a traditional IRA for 2021, you could potentially reduce your 2021 income taxes by lowering your adjusted gross income (AGI) on your tax return. Depending on your income Opens in new window, contributions to a traditional IRA are deductible for the tax year in which you make them. By putting money into a traditional IRA anytime between Jan.1 and April 15, 2022, you can choose to have that contribution count toward your 2021 tax year contributions.
Maxing out Opens in new window IRA contributions for any given tax year can help you save more money for retirement while maximizing your potential tax benefits. And, if you expect that your taxable income for 2021 will be higher than the income you expect to earn in 2022, having the flexibility to max out last year's IRA contributions might help you save more money in taxes.
If you expect to be in a lower tax bracket in 2022 than you were in 2021, your tax-deductible traditional IRA contributions could potentially help you save more money if they're designated toward your 2021 income.
Talk with a professional tax advisor for advice on your specific situation.
Choose a traditional or a Roth IRA
The prior-year IRA contribution rule applies to both traditional IRAs and Roth IRAs. Depending on your income, you can contribute to either or both types of accounts. However, you can only save up to a certain amount.
The contribution limits Opens in new window for both IRAs combined: $6,000 for 2021 (or $7,000 with extra “catch-up” contributions if you were 50 or older by Dec. 31, 2021). So, if you’re 40 and want to contribute to a traditional IRA as well as a Roth IRA, you can put $3,000 into each account for 2021, reaching the total combined limit of $6,000. Keep in mind that you can use any combination that adds up to the maximum amount of $6,000. IRA contributions are separate from any 401(k) contributions you make through an employer-sponsored plan.
The best type of IRA for you will depend on a few factors, including your age, income and tax bracket, as well as your overall plans for retirement savings and estate planning. Each type of IRA has different tax benefits and implications. For example, if you contribute to a traditional IRA for 2021, you'll likely get a tax deduction when you file your 2021 return. The savings in that account will grow tax deferred, and you'll owe taxes when you withdraw money in retirement.
On the other hand, if you contribute to a Roth IRA for 2021, you won’t receive a tax break for 2021 since Roth IRA contributions are after-tax. However, withdrawals from a Roth IRA, including any earnings, are tax-free as long a you've held the account at least five tax years and met other criteria. This means that when you use take distributions in retirement, they generally won't count as taxable income.
There’s no easy answer when deciding whether to contribute to a traditional IRA or a Roth IRA. If you’re early in your career and expect be in a higher tax bracket in retirement than you are today, a Roth IRA might give you the best tax benefits. But if you’re already in your peak earning years, and you believe you'll be in a lower tax bracket in retirement, you might want to put your money into a traditional IRA and maximize your tax savings now.
Many people like to contribute to both a traditional and Roth IRA to balance their tax savings (some today and some tomorrow) as they prepare for retirement.
It’s not too late to start
What if you don’t have an IRA? What if you haven’t started saving for retirement at all?
It’s not too late! You can still contribute up to the limit for 2021—as long as you set up your account and contributions by April 15, 2022.
Talk to a financial professional to learn more about opening a traditional or Roth IRA account.