Let’s see how a person could pay less taxes than they put away into an IRA (or 401k). We will use a simple scenario of a single person with a gross income (including interest earned) of $29,500 or less. You cannot use form 1040EZ to use this deduction that you may be eligible for, since an extra IRS form (f8880) would be necessary.
First let’s define what a “Qualified Retirement Savings” plan would be: Traditional or Roth IRAs or 401(k), 403(b), governmental 457, 501(c)(18)(D), SEP, SIMPLE plans, or the federal Thrift Savings Plan. At least that’s according to the 2013 IRS guidelines for Form 8880.
no IRA deductible
|Fed 1040 line #||Reason|
|$29,500||$29,500||1040A line 15
1040 line 22
|This is the total amount of taxable income for you, which is sometimes known as Adjusted Gross Income (or AGI).|
|- $1,985||- $0||1040A line 17
1040 line 32 & 38
|The amount that you have to deposit into an eligible traditional IRA or 401k|
|- $6,100||- $6,100||1040A line 24
1040 line 40
|For the standard deduction|
|$21,415||$23,400||1040A line 25
1040 line 41
|Income after taking the standard deduction|
|- $3,900||- $3,900||1040A line 26
1040 line 42
|Amount of personal exemption|
|$17,515||$19,500||1040A line 27
1040 line 43
|This is the final taxable income|
|$2,183||$2,483||1040A line 28
1040 line 44
|The amount of tax that is picked up from the 1040 tax tables|
|- $199||- $0||1040A line 32
1040 line 50 & 54
|Credit for retirement savings contributions!
This is an extra credit the gov’t will allow you to save if your income is low enough by lowering your actual tax paid.
|1040A line 35
1040 line 61
|This is your real tax (mouse-over the number or rate to better understand the rate)|
It is actually really close because there is either $1 less that you put into the IRA and an additional $1 in tax paid (due to rounding), or $1 more put into the IRA and $1 less in tax paid (again, due to rounding).
Most importantly, look at it this way: You could put aside almost $2,000, and $500 of that was provided by lowering your taxes! Give yourself a well deserved pat on the back for saving 20% on your taxes!
Keep in mind that you may have what seems like less money during the year depending upon how you fill out your W-4 form, but you’ve saved a LOT of money for yourself and your future, with very little effort, aside from putting away $1,485 – or $123.75/month – of your earned income).
You should also know that you could use the money from your tax return if you file early in the year (like February), and deposit the money into the deductible IRA (or 401k) marked for deposit for the previous tax year prior to the standard April 15th tax deadline.
Another benefit of using this tax credit, is that you can take the $199 credit for either a traditional IRA or a Roth IRA! The Roth IRA would only give you an extra $199 credit for your IRA because the $1,985 is NOT deductible for Federal tax purposes.
Hopefully this post is getting the folks that aren’t making that much to take advantage of these kinds of deductions while they still can. If you’d like me to calculate the maximum amount of the deduction, feel free to ask the question in a post, or by email, since this credit cannot go lower your taxes so far that you pay not taxes AND get paid to take the deduction. That is what is known as a refundable tax credit. For instance a person making only $17,750 can take advantage of this credit by putting away $1,556 (or more, but only claiming $1,556 on the form) to pay $0/zilch/nothing in Federal taxes!