Tax deductions become very interesting when you're about to file your tax return. Tax deductions save you money because they reduce the amount of tax you owe or increase the size of the refund you will receive. Most tax deductions are generated from an expense you pay. Common tax deductions include mortgage interest paid and real estate taxes paid. But there is one set of tax deductions that is even more powerful - tax deductions that you receive by saving, not spending.
Retirement Planning Tax Deduction # 1: IRA Contributions
If you contribute to a traditional IRA, you might be able to deduct your IRA contribution. Your ability to receive an IRA contribution tax deduction is based on your income and your (and your spouse's, if you're married) eligibility to participate in a workplace retirement plan. The maximum IRA contribution limit varies by year. The deadline for contributing to a traditional IRA and potentially receiving a tax deduction is not until the filing deadline of your tax return. Typically, that means you have until April 15 of the year following the year in which you will receive a tax deduction.
Since the IRA contribution deduction is not an itemized deduction, nearly everyone who qualifies for the deduction will benefit. Some other deductions are only available to those who itemize, which is not the case with the IRA contribution tax deduction.
Retirement Planning Tax Deduction # 2: Self-Employed Retirement Plan Contributions
In addition to IRAs, people who have earnings from self-employment have several other opportunities to save for retirement while saving on their taxes. Typically, the limits for contributions to such plans are much higher than those for IRAs, often reaching the vicinity of 20% of net earnings from self-employment. Self-employed retirement plans include SEP-IRAs, Keogh plans, SIMPLE IRAs, and solo 401(k) plans. Contributions to these plans are deductible as an "above the line" (not itemized) deduction and can save you a significant sum on your tax return.
Retirement Planning Tax Deduction # 3: Retirement Saver's Credit
Even better than a tax deduction is a credit. A dollar tax credit saves you a dollar in taxes, whereas a dollar tax deduction saves you some percentage less. For lower income individuals who choose to save for retirement, the tax law provides for a Retirement Saver's Credit.