Many if not most Americans are confused about which tax-saving strategies are actually legal, NerdWallet found in a 2019 tax survey it shared with CNBC Make It. As a result, millions of people filing taxes could be missing out on money-saving deductions.
One such strategy is to contribute to your IRA for 2018 after Dec. 31 but before the tax deadline in 2019. A full 75 percent of Americans think funding an IRA after the end of the year to reduce their taxable income is illegal, the personal finance site reports. That's unchanged from what NerdWallet found in its 2018 Tax Study.
The strategy is actually perfectly legal. Assuming you qualify, you have until the Monday, April 15, tax deadline to contribute to an IRA for the previous year.
The reason this particular strategy can save you money is because, when you contribute to an IRA, "you can deduct that contribution from your taxable income for 2018," Andrea Coombes, a tax specialist at NerdWallet, tells CNBC Make It.
"Say you're earning $50,000 a year. If you qualify for a deductible contribution and you can put in $5,500, the maximum in 2018 if you're under age 50, that will drop your taxable income to $44,500. If your top tax rate is 22 percent, you're shaving $1,210 off your tax bill, and you're saving for retirement, too."
Keep in mind that this strategy only applies to a traditional IRA, not a Roth IRA. "There's a lot to love about Roth IRAs," says Coombes — with this retirement account, contributions are taxed when they're made, so you can withdraw the contributions and earnings tax-free once you reach age 59½ — "but they don't give you a tax break in the year you contribute."
While anyone can contribute to a traditional IRA, for that contribution to be deductible, there are stipulations to keep in mind, says Coombes: "As long as you, and your spouse if you're married, don't have a retirement plan at work, then most likely you should be eligible to deduct your IRA contribution. If one or both of you has a retirement plan at your job, then income limits come into play. Basically, if you're doing OK, income-wise, then the rules limit how many retirement-savings tax breaks you can claim."
To see if you qualify for tax savings by contributing to an IRA, check out NerdWallet's handy chart, which breaks down the deduction limits.
A few other things to keep in mind about IRAs:
- You need to have taxable compensation to contribute
- The maximum yearly contribution for 2018 is $5,500 (though that's been raised $6,000 for 2019), or $6,500 for people age 50 or older ($7,000 for 2019)
- If you're contributing to both a traditional IRA and a Roth IRA, the maximum contribution limit applies to both accounts combined
Finally, you have to note whether you want your contribution to apply to your 2018 taxes or your 2019 taxes. So if you want to take advantage of this tax-reduction strategy this year, specify that you are making a tax-year 2018 contribution.
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