This One Thing Could Change Your Financial Health Before the Year Ends

There's no magic bullet for financial planning. Financial success is a long-term process that comes from a number of different decisions and ongoing effects, like how you spend, save, and invest. But what if you could wave a magic wand and change just one thing about your personal finances to make a big difference?

If you're doing end-of-year tax planning, or just looking at your overall financial goals, there is one small thing you can change right now that can strengthen your financial well-being for years to come.

Let's see what this smart money move is all about -- and see if you qualify.

One smart year-end money move: Put money into an IRA

Putting money into an IRA before the end of the year could be one of your smartest financial decisions. Even if you already have a 401(k) or other employer-sponsored retirement plan at work, you are allowed to open an IRA. And depending on your income and which type of IRA you choose, some or all of the money you put into your IRA this year will be tax deductible.

Putting money into an IRA before the year ends is a great way to boost your retirement savings, and potentially reduce your income taxes. No other single decision is likely to make such a big difference for your current (and future) financial health.

What is an IRA?

An IRA ("Individual Retirement Arrangement") is a type of account that lets you save and invest for retirement in a tax-advantaged way. There are two common types of IRAs that almost anyone can use: traditional IRAs and Roth IRAs.

Traditional IRAs

For most people, a traditional IRA works in a similar way to a 401(k) -- the money you put into your IRA account (your "contributions") are tax deductible. For 2023, you can put up to $6,500 into a traditional IRA. People aged 50 and older can make a "catch-up contribution" of an extra $1,000.

If you are not covered by a retirement plan at work, the full amount of your traditional IRA contribution will generally be tax deductible. There are some limits for who is allowed to deduct IRA contributions, but these rules are mostly just for people who are married to a spouse who is covered by a retirement plan at work. If you're married filing jointly and your adjusted gross income (AGI) is less than $218,000, you probably can take the full tax deduction for traditional IRA contributions.

Let's see how putting money into an IRA by the end of the year could cut your tax bill.

Example No. 1: Single person with no retirement plan at work, $60,000 of taxable income

This taxpayer is in the 22% tax bracket for 2023. So if they can put an extra $6,500 into a traditional IRA before the year ends, they will reduce their 2023 taxes by $6,500 x 0.22 = $1,430.

Example No. 2: Married couple (filing jointly) with $95,000 of taxable income

This couple is also in the 22% tax bracket for 2023. But if they can put an extra $6,500 of savings into a traditional IRA, they will reduce their taxable income to $88,500 -- putting them into a lower tax bracket (12%). Based on the IRS tax tables for 2023, this one year-end tax move will reduce their total tax from $11,521 to $10,183 -- for a tax savings of $1,338.

Roth IRAs

With a Roth IRA, you don't get a tax deduction for the money you put in. Instead, the money in a Roth IRA is allowed to grow tax free, and can provide tax-free income in retirement. Opening a Roth IRA can be a good move, especially if you're at an early stage of your career and expect to be in a higher tax bracket in the future -- the tax break you get on your current (lower) income might be worth less than the tax break you get as an older, (ideally) higher-income person.

Roth IRA and traditional IRA contributions are limited to the same total amount per year: $6,500 for 2023 ($7,500 for people age 50 and up). Not everyone is allowed to put money into a Roth IRA; there are some limitations for people with high incomes and for people with different filing statuses. But in general, these two types of taxpayers can put the full amount into a Roth IRA:

• Single people with modified adjusted gross income (AGI) of less than $138,000
• Married couples filing jointly who have modified AGI of less than $218,000

Putting money into a Roth IRA versus traditional IRA depends on your overall tax strategy and financial goals. You don't have to pick just one. You could split your money with $3,250 into a traditional IRA and $3,250 into a Roth IRA so you get a blend of immediate tax relief and future tax-free income.

Why you should use an IRA -- even if you have a 401(k) at work

If you already have a 401(k) or other employer-sponsored retirement plan, even if you're maxing out your 401(k), you can still put money into an IRA. You can put the full contribution limit ($6,500 for 2023) into a traditional IRA and get a tax deduction for the entire amount. But your modified adjusted gross income must be $73,000 or less for single filers, and $116,000 or less for married couples filing jointly.

Bottom line: Putting money into an IRA before the year ends can be one of the smartest financial moves of 2023. It's not too late! Make a plan now to boost your retirement savings.