You Have Less Than a Week to Make These Tax Saving Moves
April 09, 2015Have you filed your taxes yet? April 15th is largely known as tax day, the deadline for filing and paying our taxes for the previous year. But it’s also the deadline to make 2014 contributions to three types of accounts that can reduce your taxes now, later, or both:
Traditional IRA
As long as you qualify, you can deduct the contributions from your taxable account and reduce your 2014 taxes. The account can then grow tax-deferred and can be withdrawn penalty-free after age 59 ½ or for certain purposes like qualified education expenses or up to $10k (lifetime limit) for a home purchase if you haven’t owned one in the last 2 years.
This account can also be used as a “backdoor” way to get money into a Roth IRA if you don’t qualify to make a full contribution to a Roth IRA directly. That’s because there are no income limits to convert a traditional IRA into a Roth IRA. Just be aware that if you have any pre-tax IRA money at all, including in any other accounts, you’ll have to pay taxes on at least part of the money you convert into a Roth IRA. Fortunately, you may be able to avoid this if you can roll the pre-tax IRA money into your employer’s retirement plan.
Roth IRA
Unlike the traditional IRA, the Roth IRA doesn’t reduce your taxes now. However, it can grow to be completely tax-free after 5 years and age 59 ½ so it’s preferable to a traditional IRA if you don’t qualify for the traditional IRA deduction (the Roth IRA income limits are higher) or if you think your tax rate will be higher in retirement. Like the traditional IRA, you can make penalty-free withdrawals for qualified education expenses and up to $10k for a home purchase if you haven’t owned one in the last couple of years. If you’ve had the Roth IRA for at least 5 years, that $10k would also be tax-free.
The Roth IRA has a couple of unique benefits as well. One is that unlike other retirement accounts, you can withdraw your contributions at any time and for any purpose without tax or penalty. That means it can double as an emergency fund. (In that case, just be sure to keep the Roth IRA somewhere safe like a savings account or money market fund until you have enough emergency savings built up somewhere else. At that point, you can invest the Roth IRA money more aggressively for retirement.) If you withdraw any earnings before 5 years and age 59 ½, you may have to pay taxes plus a 10% penalty on those earnings but the contributions always come out first. (Be aware that if you convert a traditional IRA to a Roth IRA, you have to wait 5 years before being able to withdraw the converted amount penalty-free.)
The second benefit is that if you retire before qualifying for Medicare at age 65 and decide to purchase health insurance through the Affordable Care Act, the Roth IRA can help reduce your insurance premiums. That’s because the amount of the subsidies in the program is calculated based on your TAXABLE income. Since the contributions and possibly the earnings from your Roth IRA can be withdrawn tax-free, you can use it for income and qualify for bigger subsidies, which ultimately means lower premiums.
HSA
If you’re enrolled in an eligible high-deductible health insurance plan, you can contribute pre-tax money to a health savings account (HSA) and use it tax-free for qualified health care expenses. Unlike flex spending accounts, unspent HSA money can stay in the account from year-to-year and can even be invested. That can be a good idea since the account can be used for anything penalty-free once you turn age 65 or tax-free for future medical expenses, including most Medicare and long term care insurance premiums. For that reason, I don’t use my HSA for health care expenses since I’d rather let the account continue growing tax-deferred or even tax-free. (If you decide to do the same thing, just be sure to keep those medical receipts as you can still withdraw those amounts tax and penalty free in the future since the withdrawal doesn’t have to be in the same year as the expenses.)
In my case, I contribute to all three. My first priority is the HSA since it’s the most tax advantageous. I also want to make sure I contribute to it before I file my taxes since the contributions are tax-deductible.
Since my IRA contributions are not tax-deductible, I can make those contributions after filing my tax return without having to file an amended return. (My income only allows me to make a partial contribution to the Roth IRA. I then contribute the rest of my $5,500 IRA limit to a traditional IRA and convert it to a Roth IRA.)
You have less than a week before the deadline so don’t procrastinate if you plan to contribute to these accounts. Don’t let analysis paralysis stop you either. If you’re not sure where to open the accounts, just open them anywhere since you can always transfer them later. Scottrade can be a particularly good choice for IRAs since they have lots of low cost investment options and are the only investment company I know that doesn’t charge you a fee if you decide to transfer the account somewhere else.
You can reduce your taxes by contributing to these accounts. You have less than a week to do so. What are you waiting for?