By Diane Anderson-Minshall
Originally published on Advocate.com February 16 2012 4:00 AM ET
Once the clock struck midnight ringing in the New Year, you lost a lot of ways to whittle away at your 2011 taxes. But all is not lost in your blizzard of receipts, as there is one tax strategy than can help you save thousands of dollars — and many people don't even know about it.
According to TurboTax, the best-selling tax software, you have until April 17 to fund your traditional individual retirement account and still claim the tax benefit for 2011. And if you have a Keogh plan or SEP IRA, types of retirement accounts for business owners and self-employed individuals, you can get a filing extension that would allow you to make contributions to those accounts until October 15.
Making a contribution to your retirement accounts will lower this year's tax bill, and because contributions to traditional IRAs, Keogh plans, and SEPs aren't taxed, your investment will compound tax-free. For example, if you contribute just $2,000 a year for 20 years in your IRA, with, say, an average annual 8% return, your $50,000 in contributions will grow to about $124,000. But if you invested that same amount in a taxable investment account (stocks, bonds, mutual funds, etc.), your investment would reach only about $97,000 (and that's assuming you are only in the federal 25% tax bracket and live in a state with no state income tax).
If you've decided to make an IRA contribution, you need to know how much you can contribute. The annual max is $5,000 for people under age 50. If you are 50 or older, and thus closer to retirement, that maximum is raised to $6,000. The cap on Keogh or SEP contributions is $49,000. All of these accounts are taxable when you withdraw the funds in retirement. But there's also the Roth IRA, for which contributions are not deductible, but withdrawals are tax-free in retirement, which makes it a better choice for folks who'd rather pay their taxes now instead of then.
Your 2011 tax savings can depend largely on your IRA contribution. TurboTax experts say that if you are in the 25% tax bracket and make a deductible IRA contribution of $5,000, you will save $1,250 in taxes the first year but "over time, future contributions will save you thousands, depending on your contribution, income tax bracket, and the number of years you keep the money invested."