As we finished up our tax return this year, it turned out that we owed. Great. We don’t have to scrape the money together. We had planned for the extra liability when an unexpected consulting gig came together for my husband at the end of 2014. But nonetheless, it stings when you have to write a check to the Internal Revenue Service. (And besides, you just want to keep your hard-earned money for yourself!) But I was astonished with what happened next – because the solution came from yours truly and not my MBA-husband.
“You know, we can open an individual retirement account (IRA) and potentially reduce our liability,” I said. I practically turned my head around to see who uttered the words. (I think he actually did too!) My husband and I are newly married and our joint tax life is still pretty new. Last year when he prepared our first joint tax return, I happily checked out of the process leaving it entirely to his capable hands.
So what was different? About two years of reading personal finance articles day in and day out — total immersion. This year, I didn’t check out of the process. I participated in a supportive kind of way (meaning I was there to provide sustenance, moral support, hand over the appropriate paperwork at the appropriate time, and listen to his mutterings. Doesn’t everyone mutter as they prepare their taxes?) But even though we knew we would owe going into it, when he came to the end and it became clear we owed that much, we were crestfallen.
So after I suggested the retirement account, I could see the wheels turning. Within a couple seconds, he was tapping the keys to get back to the section in the software where you enter the amount you added (or intend to add) to your retirement account in 2014. He put in the full amount, made his way through the software again and – voila! – our tax liability was less by about $1,400. I felt smug. But that wasn’t all. I noticed that it also doubled the refund we were expecting from the state! Jubilation ensued.
What do you need to pursue this strategy?
Once you determine the specifics of your tax liability, your eligibility, and which type of retirement account is appropriate for your circumstances, there is one critical element you need to be able to participate: liquid assets (as in the kind you would keep available in an online savings account).
To participate in this strategy, you need to be able to fund the account – AND pay whatever your tax liability ends up being – by the date you are required to pay (usually April 15).
This means you would need to deposit up to $5,500 to fully fund your retirement account if you are under 50; if you are over 50, the maximum you can deposit is $6,500. So in our case, it was the tax liability plus the $6,500 for his account.
If you have sufficient savings to participate in this strategy, remember to tell the institution that you are making the contribution for tax year 2014 when you open the account. (Otherwise, they will attribute the deposit to the year in which they receive the funds, which could actually be deposited up until April 15, 2015.)
The amount you save in taxes depends on your income, your filing status, tax bracket and the amount you are willing to deposit into your IRA. So it is best to consult your tax professional, but we found the tax software to be more than capable of providing the correct guidance.
So, have you ever opened an IRA to reduce your taxes? Do you plan to do this every year, or do you have a different strategy?
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