What does it mean to maximize your IRA (Individual Retirement Account)?
In short, it means putting the most money possible into your traditional or Roth IRA to pave the way for a more prosperous retirement.
While IRAs are often touted for the tax-deferred growth of the investments within the account, traditional IRAs may also provide a helpful tax deduction, reducing your current year’s income tax.
In other words, every traditional IRA investment dollar you contribute may reduce your current taxable income by the same amount. However, while your traditional IRA contribution may cut your current taxes, it wouldn’t eliminate them altogether. You would owe income taxes on the IRA disbursements you receive in retirement.
Depending on your income and other factors, if you are able to contribute $6,000 of your earnings to your traditional IRA, you may be able to reduce your current taxable income by that same $6,000.1
What does that mean in current tax savings? It depends on your income bracket and whether or not you contribute to another type of retirement plan, but on average, single wage earners in the U.S. pay about 25% of their income in state and federal taxes, while married couples filing jointly pay about 20%.2
If your tax rate is 20%, a $6,000 traditional IRA contribution could cut your current year’s taxes by about $1,200. If you’re in the 25% bracket, you could reduce your current taxes by about $1,500. If you’re over 50 and can make a catch-up contribution of an extra $1,000 for a total of $7,000, you could reduce your current taxes by about $1,750. In fact, if your IRA deduction drops you into a lower tax bracket, your current taxes could be cut even further.
You could be foregoing a generous break on your current year’s taxes – not to mention the potential tax-deferred growth of the investments in your account – if you don't make the most of your IRA each year.
For contribution limits and other IRA rules, see: IRA Contribution Rules and Limits.