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Michigan Credit Union League Home » CU Community » SAS Credit Unions » Marketing » Newsletter Help » Tax Tips  

Additional Newsletter Topics

Lori Bahnmueller
Michigan Credit Union League - Your Money Matters

OK, it's income tax time again. Whether you carry a box of receipts to your local tax preparation office or spread them out on the kitchen table to try and do your taxes yourself, there is still time to take a step to reduce the taxes you will pay for what you earned in 1995. It is the #1 tax tip for most of us: an IRA.

When I say IRA, I'm not talking about Irish nationalists (which for someone with a name like Michael Kelly might be a concern), I'm talking about an Individual Retirement Account. If you don't have an Individual Retirement Account, this tax season is a good time to start one.

An IRA is a type of savings account that protects savings from taxation until you retire and begin withdrawing those savings. The tax sheltering works in two ways.

First, a single wage-earner often can deduct up to $2,000 in IRA contributions from taxable income each year, escaping taxation on that amount until it's withdrawn after retirement. That can be up to $4,000 for a working couple filing jointly.

Second, the earnings on that sum are sheltered from taxation until retirement. This means the money grows faster than it would in a regular savings account.

One of the nicest aspects of an IRA is that taxpayers have until April 15, 1996 to make their IRA contribution for 1995, meaning that you can still take a step this year to reduce your tax liability for what you earned last year.

It is best to make that IRA contribution as early as possible, however, in order to earn more interest but late is better than never.

Unfortunately, the government changed the law several years ago that allowed everyone to use an IRA. Today the law limits your ability to deduct your contribution from your taxable income if you or your spouse actively participates in an employer's IRS-approved retirement plan. If the "pension plan" box on your W-2 form is checked, you are an active participant in a plan.

If you are an active participant in a pension plan, you can still completely deduct your IRA contribution if you are:
1. Filing singly and your modified adjusted gross income is less than $25,000, or
2. Filing jointly and your combined modified adjusted gross incomes total less than $40,000.

You calculate your modified adjusted gross income using a worksheet in the IRS Form 1040 instructions. Employee retirement plan participants who exceed the income limit can still deduct part of their IRA contributions until their modified adjusted gross income exceeds $35,000 in the case of single filers or $50,000 in the case of joint filers.

Both deductible and nondeductible contributions can go into the same IRA account, but you may find it simpler in the long run to have two separate accounts. IRS regulations require that future withdrawals from your IRA be taxed on a proportionate basis.

In other words, if 60% of your IRA was deductible and 40% nondeductible, if you withdraw money from it, you have to treat that withdrawal on that same 60/40 basis. You can't withdraw from one portion and not the other unless they are clearly separated.

The IRS requires you to keep a record of what share of your contributions are nondeductible - that is, have already been taxed - so they won't be taxed again when you start withdrawing income from your IRA. To do this, file Form 8606 with your return. This maintains a year-by-year record.

An IRA is a great tax step but, probably even more important, it is part of preparing for your own retirement. It is said that nothing is certain in life except death and taxes but an IRA can make the wait a bit more pleasant on both fronts.

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