Reduce Your Tax Liability with IRA Contributions

A traditional IRA can help you out at tax time.

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Most taxpayers crack a smile during tax season because they know that they're getting a refund. The average tax refund last year was a whopping three thousand dollars, which is enough to make anyone smile. If you're one of the few people who will owe this year and want to soften the blow a little bit, here's one of the few things you can do to reduce your tax liability—make a contribution to a Traditional IRA.

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How much you save will depend on your tax bracket. One caveat, before you make any decisions, consult with a tax professional. Your situation may have wrinkles we don't cover and the last thing I want you to do is make a mistake that costs you money. A tax professional will be able to sit down with you, map out your situation, and give you the proper direction you need. We're just hoping to open your eyes to an idea that might help you out.

Deductible Traditional IRA Rules

In order to make a deductible contribution to a Traditional IRA, which is the whole point of this strategy, you have to satisfy certain conditions. Anyone with earned income can make a contribution to a Traditional IRA, but depending on the retirement package your employer offers and your income, your deduction may not be tax deductible. If it's not tax deductible, then it's really not worth investigating for the purposes of reducing your taxes.

Contribution limits: The 2010 limit for IRA contributions is $5,000 if you are age 49 and under, $6,000 for age 50 and older. The limits are shared across Traditional and Roth IRAs, so if you made a $1,000 contribution to a Roth IRA then you can only make a $4,000 contribution to a Traditional IRA (assuming you are 49 and under).

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Deductibility rules: If you are covered by a retirement plan at work, your subject to these modified adjusted gross income phaseouts:

  • For single filers: $55,000 to $66,000
  • For head of household filers: $55,000 to $66,000
  • For married couples filing jointly: $89,000 to $109,000
  • For married couples filing separately: $0 to $10,000
  • If you are a single filer that earned less than $55,000, then your entire Traditional IRA contribution is tax deductible. If you earned over $66,000, you can't deduction your contribution (you can still make it, but it has no immediate tax benefits).

    Contribution Tips

    When you make a contribution, be sure to let your administrator know that you're making a contribution for the 2010 tax year. By default, they will characterize the contribution as a 2011 contribution because you made it in 2011. Once you've made the contribution, remember to include it on Line 32 of your Form 1040 (Line 17 on a Form 1040A) so you get the tax benefit.

    You do not need to itemize deductions to get this deduction. What if you forgot to indicate your contribution was for 2010? It shouldn't be a problem, simply send them a note that you'd like them to "recharacterize" your contribution as a 2010 contribution. As long your original contribution date was before the tax deadline, they can easily recharacterize it as a 2011 contribution.

    Jim Wang writes about personal finance at Bargaineering.com. When he's not tackling money issues, he's usually looking forward to his next vacation and writing about it at Wanderlust Journey.