Tuesday Tax Tip: Fund a Traditional IRA to Reduce Your Taxes

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Every year about this time I start thinking about all the things I should have done to reduce my taxes, or I at least start scheming about what I want to do to reduce what I'll owe at the end of the next year.

There is, however, one thing you can still do (until you file your taxes) that can significantly reduce the amount of taxes you owe for last year: contribute to a traditional IRA. I've done this in years past with great success. The traditional IRA is what got me started with retirement savings.

The traditional IRA, I've found, is an excellent way to not only to reduce the amount of taxes you owe now, but also to help you save more for retirement.

About the Traditional IRA

A traditional IRA, or Individual Retirement Arrangement (Account), is a savings account into which you can make tax deductible contributions towards your retirement. Earnings from the account aren't taxed until you withdraw them. This is just the opposite of a Roth IRA, which can't save you tax money now, but will save you money on your taxes in retirement.

The money in the account can be invested in a variety of things to suit your risk level: money market accounts, bonds, mutual funds, etc. There are various income and withdrawal limitations to be aware of. I suggest you refer to the IRA Guide from the IRS website.

How an IRA Can Help Reduce Your Taxes

Because your contributions to a traditional IRA are tax deductible, they reduce the amount of taxable income for the year in which you're contributing. Therefore, you can simply designate that your contributions, made prior to April 15th or your filing date, be attributed to the previous year.

The contribution limit for 2009 is $5,000. Therefore, if you contributed the max amount, your taxes would be reduced by the result of $5,000 x your tax rate. Not bad, right?

How to Set Up a Traditional IRA

You can usually open up a traditional IRA at your bank, a large investment firm, or discount brokerage. There will be a few forms to complete, and you'll need to have your contributions funds ready. Be aware that some places have minimum requirements.

Take some time soon to do your own research, ask your tax professional, and consider making a contribution before you file your taxes.

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  1. Yep, those are the two big limitations. Thanks for sharing them, John.

  2. Note that if you are already covered by a retirement plan at work, i.e. a 401k or 403b, then there are income limits that come into play. If your adjusted gross income is over $105k you will not qualify for the traditional IRA deduction as described here.