A little background
I am an entrepreneur who spends a lot of the year making alternative income that is not taxed (at the time). Unfortunately this means that come tax season, the scene is often not pretty.
This year was no different and I spent literally dozens of hours pouring over expenses, donations, receipts, 1099s, and a million other pieces of paper to help bring my taxes down to a manageable level.
That’s when I learned one of the niftiest tax tips I have ever come across. A way to spend 10 minutes and lower my taxes due at a virtually limitless rate.
Sound too good to be true? It did for me too. Fortunately for me (and hopefully you), it isn’t. People just don’t know about it. Here’s how it works.
How it works
It is in the government’s, and your own, best interest to contribute yearly to some sort of retirement fund. Because of this, the government offers incentives for contributing to retirement funds like a 401(k) or IRA.
One particular IRA, called a traditional IRA, allows you to reduce your taxable income by contributing to the traditional IRA. What this means is if you are being taxed based on an income of $50,000, but then you donated $5,000 to your traditional IRA, you would then be taxed based on an income of $45,000.
The real kicker is that you can put this money into your IRA all the way until April 18th and still count it towards your 2016 deductions. So if you have already started doing your taxes and discovered that you are going to be paying higher taxes then you expected (or would like to pay), then you can still donate to a traditional IRA and lower your taxable income. Please note that there are limits to how much you can donate in a year.
So simply put, putting money into a traditional IRA puts money towards your retirement while simultaneously lowering your tax bill. Note that it is not a dollar for dollar deal, exactly how much it will save depends on your tax bracket, but this has the potential to drop your tax burden by more than $1,000. If you don’t have any money saved up then this won’t work for you. But if you have the money, but just don’t want to pay it in taxes, this is a smart, legal way to make that happen.
Would you rather put $500 towards your retirement, or pay $200 dollars in taxes? The choice is yours!
Getting a traditional IRA set up takes less than 10 minutes. You can literally go and sign up for one right now and be done. While there are multiple companies you can do an IRA with, I went with Motif because it is good for beginners and great on fees. The sign up questions can be a bit confusing if you don’t know finance. Here is a step-by-step process on how to get your IRA set up. Once you are done just enter it into Turbo Tax like this (or if you use another tax program enter it there).
1 – After you have clicked the link you will end up at the Motif home page. Click the link as shown in the arrow.
2 – Create a username and password that you will remember
3 – For your account type I selected individual. A margin account is if you plan to actively trade with your traditional IRA. If you don’t know what you are doing I wouldn’t recommend this. You essentially are borrowing money to invest with. If you don’t know what this means you should probably choose cash.
4 – Choose the “Traditional IRA” option. You can also open a Roth IRA later, but that will not provide immediate tax benefits. For a detailed explanation of the differences between the two click here.
5 – Start filling out your basic info. Don’t worry. They go to great lengths to keep information secure.
6 – A primary beneficiary is the first person in line to receive the funds if you pass away. You can choose multiple primary beneficiaries and their percentages.
7 – Fill out if you have any contingent beneficiaries to receive the funds if your primary beneficiary passes away.
8 – Fill out if your financial objectives and income. Generally if you have a few decades till retirement you can have a higher risk tolerance. If you are closer to retirement then you will want a moderate or low risk tolerance. Greater risk has the potential for greater rewards, but if you are closing in on retirement you typically don’t want to take on that risk.
9 – Fill out the rest of the section and be sure to be completely honest.
10 – Answer the regulatory questions honestly. These are unusual situations and typically don’t apply.
11 – You will need to sign a few agreements similar to this one.
12 – Almost done! You just need to fund the traditional IRA and you are set.
12 – The magic screen. Once the money has gone out you can report it on your taxes and you are all set. Please note, this money is not accessible before turning 59 1/2 without paying a penalty. This is money set aside for retirement. It is unwise to put money in that you plan on needing before then.
*I may (and actually do) receive affiliate commission from programs recommended in this article. I recommend the programs with the genuine belief and understanding that they are the best program for my audience. You will not pay more nor receive any worse treatment for having clicked through my link.