As an incentive to promote personal investing, the IRS
allows individuals with earned income to deduct contributions made to a
traditional Individual Retirement Account (IRA) in calculating adjusted gross
income. There are certain limits to deductibility of contributions for those
who are active in an employer sponsored retirement plan, such as a 401(k). However,
those not considered active can contribute $5,500 per person or $6,500 for
those 50 years old and over (see http://www.irs.gov/Retirement-Plans/IRA-Deduction-Limits
for deduction qualifications and contribution limits). Contributions must be
made by the due date of your income tax return, excluding extensions,
which means April 15.
Many couples are unaware that a spouse who does not
have earned income can still receive a deduction provided the couple files a
married filing joint return and meets certain requirements. This can be especially
beneficial to couples in high tax rate brackets that are looking to reduce
current tax liability by deferring it through traditional IRAs. It doesn't seem
like much, but can start to add up if you consider the long term effects.
The 28% and 33% tax rate tables in 2014 for a joint return
start at $148,850 and $226,850 for taxable income, respectively. If a couple under the age of 50
years old has $11,000 or more of taxable
income over these thresholds, then the tax deferred savings will be maximized based
on their marginal rate. Assume, for example, that a couple has taxable income
of $159,850 ($148,850 + S11,000) and they do not have the option to defer income
through employment. The deferred tax savings by each spouse contributing $5,500
would be $3,080 ($11,000*28%). The same would apply for those in the 33%
bracket. If taxable income was $11,000 or more over the $226,850 threshold,
then deferred tax savings would be $3,630 ($11,000*33%).
Now suppose the couple in the 28% bracket were 35 years old and made $11,000 ($5,500
each)of deductible contributions each year for 30 years and earned a compounded
annual rate of 5% each year through investing the deferred tax savings amount.
The potential future value just in the deferred tax savings of $3,080 each year
could be up to $215,000 in 30 years from the initial payment. A more impressive
figure is that your $11,000 annual investment for 30 years at 5% will have grown to
approximately $767,000.
For those in higher tax brackets, the future value with
equivalent assumptions would potentially yield an even higher amount. Keep in mind that withdrawals from one's
traditional IRA will be taxable, so typically those who expect to have a lower
taxable income rate at retirement or prefer more growth during investing years
should consider this strategy.
Jon Holcomb
Jon Holcomb
