Financial Education

March 1, 2018

Tax season is here, which can be a time of hope and dread for many people. It’s a time of dread for some because the process of completing a tax return can be onerous. It’s a time of hope for plenty of people because tax time often means a significant refund. For the 2016 fiscal year, the Internal Revenue Service issued 120,119,142 individual tax refunds. In 2016, the average individual tax refund was $2,795.

If you’re among the more than 120 million people who are likely to receive a tax refund this year, you are probably wondering what to do with the money you get back. Although your first impulse might be to spend your tax return on “fun” things such as vacation or a new car, deciding to invest or save your refund can help you out in the long run.

Plus, putting your return in a tax-advantaged retirement account can mean you get to enjoy additional tax benefits, and potentially a bigger refund, next year. One way you can save your tax refund for the future is to deposit it into an individual retirement account, or IRA.

If you hope to grow your tax return over time, stashing the refund securely in an IRA can help you save for the future. Read on to learn more about IRAs, what makes them a smart choice for your tax refund, and what you need to do to open one today with PeoplesBank.

What Is an IRA?

In the simplest of terms, an IRA is a retirement account that provides you with tax breaks. There are several different types of IRAs and many different options for saving or investing your money in one. There are also rules and limitations governing the amount you can put into an IRA each year and who can make contributions to your IRA. When you come to PeoplesBank, we can help walk you through these regulations.

Types of IRAs

A few different kinds of IRA are available. Each category has its own set of rules and tax advantages. You can divide IRAs into two main categories, traditional and Roth. Each group includes several smaller types or classifications. The odds are likely that when you choose to open an IRA, you’ll pick between either a Roth or traditional account.

What Are Traditional IRAs?

A traditional IRA earns its name because it’s the original form of an IRA. In 1974, the U.S. Congress passed the Employee Retirement Income Security Act (ERISA), in an attempt to provide employees with some retirement protections. A key component of ERISA was the introduction of the individual retirement account. When the act passed, people were able to deposit up to $1,500 in an IRA. The amount they contributed to their IRA could be deducted from their taxable income for the year.

A person didn’t have to pay tax on the amount in the IRA, both the original contribution and the earnings, until they began to withdraw from the account in retirement. To encourage people to leave their money in the IRA until retirement, there was an early withdrawal penalty of 10 percent, plus income tax on any amount withdrawn before a person is age 59.5. There were a few exceptions where the 10 percent penalty doesn’t apply.

As you might guess, a few things have changed about traditional IRAs over the years. While they were once only meant for employees who had no retirement plan at work, today anyone can open an IRA, as long as they are under age 70.5. The amount of the contribution limit has also steadily increased over the years, rising with inflation.

What Are Roth IRAs?

Roth IRAs are the younger sibling of traditional IRAs. In 1997, the Taxpayer Relief Act gave birth to the Roth IRA, which is named for the senator, William Roth, who designed it. The contribution limits for a Roth IRA are the same as for the traditional IRA. The big difference between the two is when you pay taxes on the amount you put into the account.

Traditional IRAs are tax-deferred, meaning you pay tax on the contributions and earnings at a later date, usually when you withdraw the funds. The money you put into a Roth IRA is after tax. That means you pay any income tax on your the funds before you make the contributions. In exchange, you don’t pay income tax on the original contributions or any earnings when it’s time to withdraw funds in retirement.

If you expect your tax bracket will be higher when you are in retirement than it is today, contributing to a Roth IRA can mean significant savings.

Who Can Open and Give to an IRA?

A few different factors determine who can fund either a traditional or a Roth IRA. For example, age matters for a traditional IRA but not for Roth IRAs. You can add money to a Roth IRA at any age. Once you turn 70.5, though, you are no longer able to make contributions to a traditional IRA. In fact, you are required to start taking distributions from your traditional IRA once you reach age 70.5.

Your income can also influence whether you may contribute to a Roth or traditional IRA and the tax advantages involved. To give to either type of IRA, you need a source of taxable income. The exception is if you’re married and don’t work. Your spouse’s income makes you eligible for contributing to an IRA.

Whether you may give to a Roth IRA depends on your total income. For people with high earnings, the contribution limit decreases the greater your income. Once it hits a certain amount, you’re not able to give to a Roth at all.

How Much Money Can You Put in a Roth IRA?

The limits on income do change based on inflation, but for 2018 you can contribute up to the limit when:

  • Your modified AGI, or adjusted gross income, is under $120,000 for head of household, single or married filing separately for separated couples
  • Your modified AGI is below $189,000 for married couples filing jointly or qualifying widow(er)s
  • You can contribute a reduced amount if:
  • Your modified AGI is between $120,000 and $135,000 and you are married filing separately for separated couples, head of the household or single
  • You are married and filing jointly or a qualifying widow(er) with a modified AGI between $189,000 and $199,000
  • You are married and filing separately but living with your spouse and make a modified AGI less than $10,000
  • You cannot give to an IRA if you:
  • Cohabitated with your husband or wife at any point in the previous year and are married and filing separately
  • You have a modified AGI of more than $199,000 and you are married and filing jointly or a widow(er)
  • You have a modified AGI of more than $135,000 and you are head of household, single or married and filing separately for separated couples

How Much Money Can You Save on Taxes With a Traditional IRA?

Your income doesn’t influence whether or not you can contribute to a traditional IRA during the year. Whether you or your spouse have a retirement plan at your job does affect the contribution you can deduct from your income.

If you or your spouse has a retirement plan with an employer, you can contribute up to the limit, but you might not be allowed to deduct your entire contribution. For 2018, the IRS has set limits for people with a retirement plan sponsored by their employer. You can deduct the full amount of your traditional IRA contribution if you have:

  • Modified AGI under $63,000 for single or head of household
  • Modified AGI under $101,000 for qualifying widow(er)s or married and filing jointly
  • You can deduct part of a traditional IRA contribution for those with:
  • Modified AGI between $63,000 and $73,000 for head of household or single
  • Married and filing separately with a modified AGI under $10,000
  • Modified AGI between $101,000 and $121,000 for qualifying widow(er)s or married and filing jointly
  • You can’t deduct any of a traditional IRA contribution, but you can still contribute for those with:
  • Modified AGI over $73,000 for single or head of household
  • Modified AGI over $10,000 for married and filing separately
  • Modified AGI over $121,000 for married and filing jointly or qualifying widow(er)s
  • If you don’t have a retirement plan at your job but your spouse does, and you file a joint return, that can affect how much of a traditional IRA contribution is deductible. The limits for 2018 for couples where one partner is covered by an employer-sponsored retirement plan are:
  • Modified AGI under $189,000 for married couples who file a joint return: You can deduct the full traditional IRA contribution.
  • Modified AGI between $189,000 and $199,000: You can deduct part of the amount you contribute.
  • Modified AGI over $199,000: You can’t deduct any part of your contribution.

What Amount Can You Contribute to an IRA?

The amount you can give to either a traditional or Roth IRA depends on a few things — the total contribution limit, your age and your income. For 2018, the contribution limit for Roth or traditional IRAs is $5,500 for those under age 50.

It’s worth noting the $5,500 is a combined limit. You can’t put $5,500 into a Roth and another $5,500 into a traditional IRA — your $5,500 contribution can go to either account or in combination. For example, it’s okay to put $2,000 into a Roth IRA and $3,500 into a traditional IRA during a single year.

People over the age of 50 have the option of contributing an additional $1,000 per year to their IRAs, making their total contribution limit $6,500. People over age 70.5 can’t add money to a traditional IRA at all but can continue to put money into a Roth IRA.

There are some cases when a person isn’t able to make the full contribution. High-income earners might not be allowed to give to a Roth IRA or might have a reduced contribution limit. People who have small incomes are also limited. For example, if your modified AGI is less than $5,500, you can only contribute up to the total of your annual salary. If you earn $3,000, you can’t put more than $3,000 into an IRA during that year.

What Happens to the Money in an IRA?

One source of confusion surrounding IRAs concerns what happens to the money when you open an IRA. People often mistakenly assume IRAs are like stocks or mutual funds or that an IRA functions as a type of investment vehicle.

In reality, an IRA can be many different things. Some people do open investment-based IRAs, which allow them to purchase stocks, mutual funds or exchange-traded funds with their retirement savings.

In other cases, IRAs take the form of savings accounts or certificates of deposit (CD). Like non-IRA savings accounts or CDs, the money in an IRA savings account or CD earns interest and is insured by the FDIC. The type of IRA you decide to open depends in part on how near or far you are from retirement, your overall financial goals and your tolerance for risk.

Why You Should Have an IRA at PeoplesBank

You’ve probably heard that the state of retirement planning and savings in the U.S. is in flux. According to research from the Pew Charitable Trusts, 35 percent of all workers over the age of 22 don’t have any access to a retirement plan sponsored by their employer. According to data from the Economic Policy Institute, the median retirement savings amount for people ages 32 to 37 was just $480. The median savings amount for people aged 56 to 61 was $17,000.

Among the obstacles standing in the way of saving for retirement is a lack of access to a retirement savings plan and the notion that saving for retirement isn’t affordable. While employer-sponsored plans might have some hoops people need to jump through to qualify, that’s not the case with an IRA.

As long as you have some source of taxable income, you can open and contribute to an IRA at PeoplesBank. If money is particularly tight, you can hold off on putting in money during a given year.

IRAs can also be considerably more affordable than other savings or retirement plan options. While contributing to a 401k — if your employer offers one — requires setting up a contribution for each pay period, the contribution schedule for an IRA is much more flexible.

Many have very low minimum amount requirements. You’re also able to make contributions on your own schedule. For example, if you anticipate getting a few thousand dollars back as a tax refund, you can fund your IRA once a year using your tax refund.

Should I Put My Tax Return in an IRA to Reap Tax Benefits?

Both a Roth and a traditional IRA offer tax benefits, either now or down the line. When you make contributions to a traditional IRA, you reduce your taxable income for the current year. That can mean that you have a lower tax bill and might get even more of a refund during tax season. The only exception is if you have a retirement plan at your job and earn over the income limits or if your spouse has a retirement plan from their employer and your combined income is over the limit.

Even if you can’t take advantage of deducting a traditional IRA contribution from your current income, you can still enjoy the benefits of paying deferred taxes on the amount the account earns. Whether your traditional IRA has earnings from interest or dividends, you won’t be taxed on those earnings until you begin to withdraw from the account.

The tax benefits of a Roth IRA are slightly different. With a Roth, you aren’t deducting the amount you contribute from your taxable income for that year. Instead, you pay income tax on the amount you put into the account in the year you contribute.

The exchange is you don’t need to pay taxes on it when it’s time to withdraw from a Roth IRA. You’re also off the hook for paying tax on any interest or dividend earnings in the account. Depending on what your income tax bracket is during your retirement years or depending on what your Roth IRA earns over the years, that can mean significant tax savings for you.

What Should I Do With My Tax Return? Put It in an IRA

In some cases, using your tax refund to fund an IRA makes particularly good sense. Depending on when you make the contribution and the type of IRA, investing your tax refund into an IRA can help lower your tax bill for the current year.

While December 31 is the deadline for most tax writeoffs, the rules are a bit different for IRAs. You have until April 15 of the next year to make contributions to an IRA credited to the previous year. So, for 2017, you have until April 15, 2018, to contribute up to the full amount of your IRA.

When Do I Need to Open an IRA to Get the Tax Benefit?

Another loophole lets you take advantage of tax savings with an IRA contribution. You can declare you’re going to make a contribution and claim that contribution on your tax return before you’ve done it.

Let’s say you plan on opening a traditional IRA account using the money from your tax refund. You file your tax return in February, well before the April deadline. On the line for traditional IRA deductions, you put in $5,000, even though you haven’t contributed yet.

You then deduct $5,000 from your taxable income, lowering your adjusted gross income and receiving a tax refund of $5,000. You get the money for the refund before April 15, and you open your traditional IRA. Since the money moved into your IRA before the deadline, you don’t have to make any changes to your tax return, and you boost your refund.

Had you not deducted the $5,000 and put that money into an IRA, your taxable income would have been $5,000 more.

If you plan to use your tax return to fund last year’s IRA, keep in mind it’s essential the money gets into your IRA by the April deadline. If it doesn’t, you’ll most likely need to file an amended return and might lose a part of your total refund.

How to Open or Contribute to an IRA at PeoplesBank

If you’ve decided that a traditional or Roth IRA is one of the smartest investments for a tax return, here’s what you need to do to get the ball rolling and to open your account at PeoplesBank:

  • Decide whether you’d like a traditional or Roth IRA. Do you want to take advantage of a tax deduction now or avoid paying taxes in retirement?
  • Decide how you’d like to save or invest your money. At PeoplesBank, you can open an IRA with a minimum contribution of $1,000. The “Step it Up” IRA features a rate increase every six months, while the “Bump Up” IRA lets you switch to a higher interest rate once over the life of the IRA. While IRAs are FDIC insured, contributions to stocks or other investment vehicles aren’t and might lose value.
  • Open an account. If you already have an IRA, making a contribution is as easy as transferring your tax refund into the account. If you need to open an IRA, the team at PeoplesBank is happy to walk you through the process. You’ll need some identifying information, such as your Social Security number, driver’s license or passport number, and your citizenship status when you create a new account.

Why Choose PeoplesBank? You’re Welcome Here

Why come to PeoplesBank when opening an IRA? We make it a point to welcome all of our clients and provide caring and knowledgeable service. We’ve been serving people in York County and the surrounding area for more than 150 years and have maintained the same core values throughout the time, even as technology and account options have advanced and evolved.

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