2015 is over, and it's too late to take advantage of most tax deductions. However, there is one big way you could still increase your 2015 tax refund, or lower the amount of tax you'll owe: contributing to retirement accounts. For most people, this means a traditional IRA, and you may be surprised just how much of a tax benefit this can be.
You have until April 18 to contribute to certain types of accounts
If you have a 401(k) or other retirement plan at work, you generally can't contribute to it for the 2015 tax year anymore (contact your plan administrator to confirm). However, many people don't realize that you can contribute to other types of retirement accounts for 2015 all the way until the tax deadline, which is April 18, 2016.
This includes the following types of accounts:
- Traditional and Roth IRAs
- SIMPLE IRAs
- Solo 401(k)s
Roth accounts are great for several reasons, but they unfortunately won't help your tax refund this year. The latter three account types listed -- SEP-IRAs, SIMPLE IRAs, and Solo 401(k)s -- are great for self-employed individuals or small business owners. To help you make a smart choice, here's a good discussion about choosing the best IRA for you -- Roth, traditional, or one of the other options.
For our immediate goal of tax savings, Traditional IRAs are the most common way the average taxpayer can still boost their tax refund after the calendar year has come to an end. For the 2015 tax year, you can contribute up to $5,500 to a traditional IRA, with an additional $1,000 "catch-up" contribution allowed for savers over 50.
Can you get a deduction?
Depending on your income, marital status, and whether or not you can participate in a retirement plan at work, you may be able to deduct the money you contribute from your taxes.
- If you (and your spouse, if applicable) do not have the ability to contribute to a retirement plan at work, you can deduct your traditional IRA contributions no matter how much you earn.
- If you're single and can participate in a plan at work, the maximum adjusted gross income for a full deduction is $61,000, and the deduction phases out completely for AGI above $71,000.
- If you are married, and your spouse can participate in a retirement plan at work, but you can't, your ability to take a full deduction begins to phase out if your combined AGI is more than $184,000, and it disappears completely for AGI above $194,000.
- Finally, if you're married filing jointly and are able to participate in a plan through work, the full deduction AGI limit is $98,000, and the maximum for a partial deduction is $118,000.
Also, keep in mind that retirement savings get you an above-the-line tax deduction, meaning you can use it whether or not you choose to itemize.
The tax benefit could be huge
Let's say you're married, and you and your spouse earned $110,000 combined in 2015, and that after all of your other deductions and credits, your taxable income is $85,000. This means you'll be in the 25% tax bracket for 2015, and that all of your income above $74,900 will be taxed at this rate. If you choose to open a traditional IRA and contribute the $5,500 maximum (assuming you're under 50), this translates to a tax savings of $1,375. Not a bad deal for doing something you should be doing anyway -- saving for your future. Plus, your spouse can open their own IRA, effectively doubling the benefit -- assuming you both qualify for a deduction.
It's also worth mentioning that for the self-employed retirement saving options I discussed earlier, the contribution limits, and therefore the tax deduction, are even bigger. So, if you have any self-employment income such as from a business you own, consulting, or freelance work you do on the side, they are certainly worth looking into.
The tax deduction isn't even the best part
If you contribute the maximum amount to your traditional IRA, you could add $1,375 to your tax refund this year. You can do the same for the 2016 year, and every year thereafter at whatever the maximum is then (the maximum contribution will likely increase after 2016 to keep up with inflation).
The best thing about this strategy is that if you do this every year, you could end up with a massive retirement nest egg. A $5,500 traditional IRA contribution each year compounded at the stock market's historical average total return for 30 years could grow to more than $820,000. And, keep in mind that this is in addition to any other retirement savings or pension plan you may have.