It’s that time of year again — the dreaded tax time. Fortunately, there are a few things you can do to make filing your taxes easier. For one, if you’re thinking of filing for bankruptcy to deal with income tax debt, you may want to look over other options. Tax debts are not dischargeable in bankruptcy, but in some financial situations, bankruptcy may still be a good choice. For example, if you have mounting medical or credit card debt that led you to put off paying your taxes in the first place, filing for Chapter 7 or Chapter 13 bankruptcy can help.
But perhaps you’re not here because you’re staring down impossible tax debt. Maybe you’re hoping to just get a little back on your taxes this year or at the very least, reduce the amount that you owe. One way people do this is by opening a new IRA account or contributing to an existing one. Of course, if you’re struggling to pay bills or looking for savings around every corner, you may not have an extra $5,500 sitting around. But don’t let that throw you — that’s just the maximum contribution amount for most people each year they can put toward an IRA.
What is an IRA?
OK, so if this your first time hearing the abbreviation “IRA,” you may be wondering what it stands for. An IRA is an Individual Retirement Account, and it’s different from the 401(k) you may already have through your employer. How?
Essentially, an IRA is an account you open on your own that can include investments such as stocks, bonds, mutual funds, and other assets. A 401(k) is only through an employer. There are caps to how much you can contribute to an IRA each year, as well as eligibility rules in terms of your income and job status. Similar to a 401(k), you also can be penalized if you take money out of your IRA before retirement.
Here are a few of the major types of IRAs.
Traditional IRAs are tax-deferred, meaning you only pay money on them once you start withdrawing from the account, usually once you turn age 59 ½. This type of IRA can grow faster than others because no taxes are collected on dividends, interest, and capital gains before withdrawal. Your traditional IRA may be deductible or nondeductible.
With a Roth IRA, money you contribute is funded after taxes — meaning you’ve already paid them before the investment. When you withdraw at retirement, you don’t pay any additional taxes. Your contributions to a Roth IRA also may be limited depending on income. This is the only IRA you can continue contributing to if you’re older than age 70 ½, when you have to start taking Required Minimum Distributions (RMDs) from your retirement accounts.
This is a type of traditional IRA for self-employed folks, freelancers, and small-business owners. A SEP IRA has tax-deductible contributions for both the business and individual, but employees cannot contribute — just employers. SEP IRAs have a much higher contribution limit than a traditional IRA and can exist alongside traditional and Roth IRAs in a consumer’s investment portfolio.
A SIMPLE IRA stands for Savings Incentive Match Plan for Employees. It is tax-deductible and works similarly to a traditional IRA. While employees are able to make contributions to these plans, whether or not they do, employers are required to contribute either a dollar-for-dollar match of up to 3% of an employee’s salary or a flat 2% of their salary. SIMPLE plans also have higher contribution limits.
For more details on other types of retirement plans, including 403(b) Plans and Payroll Deduction IRAs, click here.
Contributions Limits for IRAs
IRA contribution limits can be tricky, but if you do them correctly, you may see a benefit around tax time. While you are able to contribute to an IRA if you or your spouse have a 401(k) through work, you may not be able to deduct all of your traditional IRA contributions if either of you have both.
Your total contributions each tax year to traditional and Roth IRAs cannot be more than $5,500 or your taxable compensation for the year, if it was less than $5,500. If you’re age 50 or older, you can contribute up to $6,500. This doesn’t apply to rollover IRAs or qualified reservist repayments.
If you contribute more than these regular limits, you will be taxed. You also will be taxed if you make an improper rollover contribution or contribute to a traditional IRA if you’re over age 70 ½. The excess-contribution tax is 6% per year for however long the excess amount remains in your IRA, so make sure to withdraw this and any income made on an excess contributions before your taxes are due!
Deductions for IRAs
Now for the big stuff: deductions. These may be claimed on federal taxes for contributions made to an IRA in a given tax year. Note that Roth IRAs are not tax-deductible — this section only applies to traditional IRAs.
For traditional IRAs, your deduction may be limited if again, you already have a retirement plan through work or your spouse does and you make too much money. If neither of you have a retirement plan through work, you’re in the clear: you’ll be able to take the full tax deduction for your IRA. If you are married and filing taxes jointly but your spouse is covered by an employer retirement plan and you’re not, you’ll still get a full deduction up to the amount of your contribution limit if your modified adjusted gross income is $186,000 or less.
The good news about deciding what to contribute each year is that you have up until taxes are due to contribute to an IRA that counts for the tax year in which you are filing. So, you can technically contribute twice in one calendar year to your IRA if you come across extra savings or income and have it apply to different tax years.
Choosing the IRA That’s Right for You
You’ll have to weigh the benefits of the types of IRAs and what your financial situation may call for this tax season — and long term. If you’re just starting out in retirement investing, contributing the full amount (if you have it) in a new traditional IRA might be better for you than contributing to a Roth IRA just yet. It really depends on your retirement goals as well as your current income taxes. A qualified tax accountant should be able to help you make several decisions, including giving advice on where to open an IRA and how IRAs will affect your taxes and your retirement plans.
There’s a lot more about IRAs to know that we can’t cover in just one blog post, so check out some of these resources for more information:
- My Son Just Started His First Part-Time Job. Can He Open an IRA?
- Retirement Savings Contributions Credit (Saver’s Credit)
- The Benefits of Starting an IRA for Your Child
- Will Bankruptcy Take Out My 401(k) and Retirement Accounts?
- Can I Retire Early in LA?
If you are looking for information on how to keep your retirement plans during bankruptcy, contact an experienced Los Angeles bankruptcy attorney today. At Borowitz & Clark, we have helped thousands of people get out of debt and back on the path toward a healthy and happy retirement. Our initial debt consultation is always free.
Barry Edward Borowitz is the founding partner of Borowitz & Clark, LLP, a leading bankruptcy law firm that represents clients petitioning for bankruptcy protection under Chapter 7 and Chapter 13 of the bankruptcy code. Mr. Borowitz has been practicing bankruptcy law exclusively for more than 15 years. View his full profile here.