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The Average American Got a $4,781 Tax Deduction by Doing This. Did You?

By Dan Caplinger - Jan 17, 2016 at 8:01AM

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Looking for a last-minute tax break? Here's something that will fit the bill nicely.

Source: Flickr user Frankleleon.

As tax time approaches, millions of taxpayers will work hard to find any possible way to reduce their tax bills. Most Americans are eligible to take a key deduction that will let them reduce their taxable income by thousands of dollars. Despite this opportunity, very few people actually follow through to reap the benefits of this tax benefit. Let's take a closer look at the deduction for traditional IRA contributions and whether you can take advantage of it.

The benefits of IRAs
One of the biggest benefits of saving for retirement using a traditional IRA is that you can generally deduct the amount you contribute from your current-year tax return. For 2015 and 2016, if you get income from a job of run your own business, you can contribute as much as $5,500 to an IRA. Those who are 50 or older can add another $1,000 to their IRA contributions.

Contributions to a traditional IRA are fully deductible unless you or your spouse is covered by another retirement plan such as a 401(k) plan at work. Even those who do have coverage from an employer-sponsored retirement plan can still deduct traditional IRA contributions if their earnings are less than the following income limits:

Source: IRS.

Moreover, higher limits apply to those whose spouses are covered by a plan. Joint filers can get a full deduction with income up to $183,000, and that deduction phases out between $183,000 and $193,000.

A surprising low number of people use the IRA deduction. In the most recent year for which data is available, the IRS said that only about 2.7 million taxpayers claimed an IRA deduction. Its calculations show that the total deductions amounted to almost $13 billion. When you do the math using more precise figures the IRS provided, that comes to around $4,781 per return. That sounds as though many people are contributing the full amount, but bear in mind that the figure includes joint filers for which both spouses could potentially contribute.

Depending on what tax bracket you're in, a $4,781 deduction could produce tax savings of between $478 and $1,893. Yet with more than 147 million taxpayers filing returns, fewer than 2% of American households are claiming the IRA deduction and adding to their retirement savings.

Another reason to save
For some taxpayers, there's an additional incentive for contributing to an IRA. The Retirement Savings Contributions Credit offers another tax break for IRA contributions, giving you a credit of between 10% and 50% of the first $2,000 you contribute to a qualifying retirement account. In addition to IRA contributions, anyone who participates in a 401(k) plan is also eligible.

The credit has income restrictions that are fairly limited -- as you can see below, you have to earn less than $30,500 for single filers or $61,000 for joint filers to qualify for any credit. Yet if you do qualify, the credit can add between $200 to $1,000 in further tax savings. About 7.4 million American taxpayers took advantage of the credit in the most recent year, and their credits amounted to more than $1.3 billion -- roughly $178 per return.

Source: IRS.

The obvious question is why more people don't use traditional IRAs with all the tax breaks they offer? One good reason is that if you have access to a 401(k) plan, it can be a better choice than an IRA if your employer provides matching contributions for your own savings. If you have limited money to contribute and you can't save in both a 401(k) and an IRA, getting the free money from your employer is an extra incentive you shouldn't pass up.

Secondly, the IRS data only talks about traditional IRAs and leaves out Roth IRAs. For many taxpayers, Roth IRAs are a better choice, because even though they don't give you a current deduction, they offer tax-free treatment for the growth in your retirement assets. Many taxpayers are willing to make that trade-off, and Roth IRAs are also eligible for the Retirement Savings Contributions Credit.

Nevertheless, the best attribute of a traditional IRA contribution is that you have until April 18 to make a deduction that counts against the 2015 tax year. Few other deductions let you claim them that late. So if you're looking for a last-minute tax break, a deductible IRA might be exactly what you're looking for.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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