Traditional IRA

Do You Have A Traditional IRA?

I recently prepared a return for a client and then emailed her to let her know the outcome. I also told her how much her refund would be if she contributed just $3k to a traditional IRA. I do that a lot with my clients just because they may not know.

 

She emailed me back and asked me to explain to her how IRA’s worked. So I thought if she didn’t know how an IRA worked, maybe you didn’t either. Knowledge is power right, that’s how we learn and grow.

 

Here’s how it works. A traditional IRA is an individual retirement arrangement that you set up with your financial advisor. If you don’t have a financial advisor you can reach out to your local Thrivent or Edward Jones office or even ask your bank.  

 

Once you have your account established, you “deposit” money into the account and then take that amount as a deduction on your tax return. The money you “deposit” is used to buy shares of stocks, mutual funds, or whatever instrument you chose as your retirement investment.

 

The reason I like this strategy is because the amount you contribute to a traditional IRA is subtracted from your income on your tax return before taxes are calculated. For instance, if your tax rate is 20% and you contribute $3k to an IRA, then your taxes are reduced by $600, giving you an instant 20% return on your investment.

 

One of the cool things about a traditional IRA is, you have until April 15th of the following year to make the contribution for the previous year. If you haven’t filed your taxes yet for 2023, you still have time to put money into or open an IRA account if you don’t have one so that you lower your tax liability for last year.

 

If you do that, make sure that you are crystal clear with your advisor that you want the amount to be credited to the prior year and not the current year. Be sure to look at your statement or receipt to see which year is listed.  

 

I know what you’re thinking because I hear it all the time. 

“Yeah, but paying $3k to save $600, doesn’t seem like a good deal to me”.  

Did you have that thought?

 

Listen – You’re not paying anything – You’re investing in yourself! That $3k is still your money. It’s not gone. You’re just moving it from your checking/savings account to an investment account for your future. You still own it, but now, you’re being strategic with your money.

 

Think about when you go shopping. You look for a good deal. Right? You check online at different places, maybe, you clip coupons – how many times have you looked for a Kohls 30% off coupon? It’s the same concept.

 

Instead of using a coupon you’re using a strategic plan to get a discount on your taxes and the bonus is you’re investing in your financial future at the same time.

 

This is definitely a strategy that you should be taking advantage of if you’re serious about taking control over your money and creating financial security for yourself.

 

That $600 savings is just on your federal tax return. You could save another couple hundred dollars on your state return, depending on your states tax code and your tax rate.  For instance, in MO, it would save you another 6%. That’s a 26% instant ROI. I mean, you are not going to get that kind of instant return on your money anywhere.

 

You can contribute as much as $6,500 for 2023 if you’re under the age of 50. And $7,500 if you’re over the age of 50 and of course the more you invest the more savings it will net you on your taxes. And remember, you can do this until you file your tax return or April 15th.

 

EXAMPLE OF SAVINGS FOR MAXIMUM CONTRIBUTION FOR 2023

If you’re under 50 – $6500 x 20% (federal tax rate) = $1,300 in tax savings

If you’re over 50 – $7500 x 20% (federal tax rate) = $1,500 in tax savings

 

EXAMPLE OF SAVINGS FOR MAXIMUM CONTRIBUTION FOR 2024

If you’re under 50 – $7K x 20% = $1,400

If you’re over 50 – $8K x 20% = $1,600

 

Of course, like everything, there are some income limitations around who can contribute. Here’s a brief overview.

 

The phaseout starts at $138,000 for Single taxpayers and completely phases out once your modified adjusted gross income on your tax return reaches $153,000 for 2023. Meaning, if you make between $138k and $153k, the amount you get to take as a deduction phases down until you reach 0.

 

For married taxpayers filing joint return, the phaseout starts when your modified adjusted gross income reaches $218K and completely phases out at $228K.

 

If you participate in your employers 401k plan, you can still contribute to a traditional IRA and get a tax deduction but the income limits are lower.  One big difference between a traditional IRA and a 401k is, you can put a whole lot more money into a 401k than you can a traditional IRA but you cannot contribute to your 401k after the calendar rolls over like you can a traditional IRA.

 

When the calendar rolls over, you’re done with your 401k but you can still invest in a traditional IRA until April 15th of the following year.  

 

Both of those strategies are a huge way to shelter your income from taxes. So, the more you contribute, the more your taxes will go down.

 

The other thing that I hear people say is 

“Yeah, but I don’t have $3k to contribute to an IRA”. 

OK, let’s talk about that.  

 

Why don’t you have $3k to invest?

 

We all have monthly expenses. Where are your priorities?

 

This is not a judgement, where your money goes is where your priorities are. That’s just how we operate as humans.

 

If you need help with mapping your money or setting your income goals, read my blog ppsaccounting.com/setting-your-income-goal-a-roadmap-to-financial-success/ or my Debt Snowball blog ppsaccounting.com/debt-snowball/

 

If you don’t take control of your financial future, no one else will do it for you.

 

Not having a strategy plan is costing you more than just the monthly payments you’re dishing out every month. It’s keeping you from being able to

  1. Invest in your financial future
  2. Being able to take advantage of tax savings opportunities and other financial strategies
  3. And when you have more payments going out than you have coming in, it robs you of your freedom of choice.

If you don’t have the money to contribute a lump sum amount to an IRA for 2023, start planning for 2024 now. Ask your financial advisor to auto draft it from your account each month. Set it up to be part of your monthly expenses on your money mapping worksheet.

 

Taking advantage of the traditional IRA is just one strategy you can use to help build wealth and create a thriving financial future. Layering this strategy with others can further enhance your financial success and stability over time.

 

Understanding the foundation of how money works and understanding your own money mindset is the first step toward achieving financial freedom. You have to know what your goals and your values are and then spend your money in alignment with them. That’s how you achieve financial success.

 

For more tax tips and strategies, visit our website www.ppsaccounting.com