’Tis the Season for Tax Time
As the year winds down, ’tis the season to wrap things up (not just holiday gifts; but all the projects we’ve started and haven’t yet finished). We also approach the New Year where we resolve to start what we haven’t yet begun.
One might also refer to this period as tax time – with a December 31 end date for the current tax year for most filers. Those IRS deadlines are right around the corner, so it’s time to ensure accounts and records are in order.
With that in mind, contributing to an Individual Retirement Account is a timely consideration throughout the year or at year’s end. That is, these specialized funds can take advantage of annual IRS allowances that help manage one’s tax position.*
Two IRAs, Two Tax Positions
- A Traditional IRA is tax-deferred, which means the contributions that go in are not taxed until they come out. That means if one were to contribute X-amount of money during the course of any given year, then there would be no tax due on that amount in that year. It’s a way to lower one’s income-tax obligation for the current year.
Plus, when retirees eventually withdraw the money (age 591/2 or later) and pay taxes on it, their tax bracket could potentially be lower than it would have been if they paid taxes before retirement. In other words, people often have less income in retirement, which can translate to a lower tax obligation at that time when they take their IRA distributions.
Also, because the amount that would have otherwise gone to taxes remains in the Traditional IRA account earning interest, the growth potential is optimized through the benefit of compounding.
- A Roth IRA is not tax-deferred, which means taxes still have to be paid on the funds going in, but withdrawals are then tax-free at retirement age (591/2). The key benefit here is that no matter how much the fund might grow, there is no tax on the income that is withdrawn during retirement. Imagine an individual who started saving for retirement in their 20s and retired in their 60s. That would be 40 years of tax-free growth potential with a Roth IRA, translating to tax-free income distributions later in life. And no matter when one starts saving—age 30 or 40 or 50, etc.—the retirement income is still tax-free as indicated in this example.
One does not know what the future will hold. Tax brackets are subject to change over time. By paying taxes now versus later with a Roth IRA, retirees don’t have to worry about whether or not their tax obligation will have gone up or down at a time when they may have less tolerance for economic fluctuations.
So, both types of accounts can play a strategic role in tax planning.
For either type of IRA, the contribution limit for 2021 is $6,000 per year for most filers and $7,000 for those age 50 or older (for 2022, these amounts are slated to remain the same as of
this publication date).* And one can have both types of accounts. If an individual is maxed out on Traditional IRA contributions for the year already, then a Roth IRA might still be an option. Or, maybe an individual has one type of IRA account at work and wants to diversify his or her tax position by contributing to the other form of IRA through Pinnacle Bank.
Whether starting out the New Year with a new IRA and making regular contributions over time, or doing a single catch-up contribution by tax day, for the current tax year, either option can be accommodated. As long as investors stay within annual limits and meet other qualifications, IRAs can be a supportive part of a diversified plan to save for retirement right now… and save on taxes, now or later (most filers have until tax day 2022 to contribute for the 2021 tax year).
Make Tax Time Less Taxing with Pinnacle Bank
*The rules regarding IRA contributions, eligibility, taxes, limits and more can vary based on each taxpayer or situation. Consult your tax advisor and financial planner to discuss the considerations that may apply.