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Your Taxes and IRA Contributions

Posted on 25, Nov, 2013

You're probably already fully aware that an IRA is a great way to plan for your retirement, but what you may not have realized is that your IRA is also a great way for you to save on your taxes (if you qualify) for every single year you contribute to your IRA (Individual Retirement Account).

Unfortunately most people leave planning their retirement until they're well into their 20's or 30's, when in reality the single best time to start planning your retirement is the day you start your first job. That's not to say that you can't plan for your retirement when you're 30, or even 40 - it just makes the task that little bit more difficult than it needs to be. We understand that the idea of planning your retirement the day you start in a new job might seem a bit morbid, but there are some very valid reasons for taking this approach.

Basically the sooner you start building your IRA the more money you'll have available to you at retirement, and when you factor in inflation and an increase in the cost of living you'll see the later you leave planning for your retirement the more money you'll have to pump into your IRA to get where you need to be - the longer the IRA is in existence the more interest you can earn and the more comfortable you'll be later in life.

The major perk for placing your retirement funds within an IRA is because they can provide you with a certain amount of legal protection from taxes. So in a typical year, and until regulations change, you can contribute up to US$5,500 to your IRA, and although you can own multiple individual retirement accounts your total annual contribution to them can be no more than US$5,500. If you're over the age of 50 however you can contribute up to US$6,500 per year in total tax free, allowing for those of you who might be in a bit of a rush to get your retirement plan together at the "last minute".

If you already have an existing retirement plan in place with your employer in the form of a 401(k) you might qualify for the IRA tax relief which is available, but only if your Adjusted Gross Income (AGI) is under the threshold.

Once your funds are safely inside your IRA you won't have to pay any taxes on them until, or if, you start making withdrawals from it. If you withdraw cash from your IRA before you reach 59.5 years of age you'll incur a penalty of 10% and you will also be liable for the ordinary level of income taxes you'd pay if you were working.

Some of you are probably wondering "Is a Roth IRA better than a standard IRA" for making a tax free contribution towards your retirement? You can't really compare apples with apples here but some differences like any cash withdrawals from a Roth IRA being tax free can appeal to certain investors more than they might expect.

Which you choose in the end however will be entirely down to your own particular financial and retirement needs

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