Looking for Another Deduction? Open an IRA or a HSA

by Miranda Marquit · 9 comments

As you figure your taxes this year, you might be looking at the result and thinking that it would be nice if you could deduct just a little bit more from your income. Even though a tax deduction isn’t as valuable as a tax credit, it can still help you by lowering your tax liability and reducing what you owe overall.

Plus, if you are worried about finding yourself in the next tax bracket up, another deduction or two can really help. But it’s too late — the year has ended. Any deductions you take go toward your next tax return, right?

The good news is that you still have a way to make a deduction for the previous year. Individual Retirement Accounts (IRAs) and Health Savings Accounts (HSAs) allow you to make tax-deductible contributions up until tax day, so you have a chance to boost your deductions if it looks like it will help your cause.

Previous Year Deductions

A traditional IRA (contributions to a Roth IRA aren’t tax-deductible) allows you the option to make a “previous year contribution.” The HSA has this option as well. As long as you make your contribution before tax day, and as long as you remember to check the proper box in your paperwork or online, you can use the contribution to lower last year’s income for tax purposes.

You do have to realize, though, that once that money is earmarked for use in reducing last year’s income, it can’t be used on next year’s tax return to reduce this year’s income. Each contribution can only be used for one tax year.

Opening a New Account

If you don’t have a traditional IRA or a HSA to make contributions, you can open one and deduct the amount that you fund the account with. There are eligibility requirements, though. Plus, there are limits to the amount of money you can contribute to each account. Check to make sure you meet the requirements, and that you aren’t trying to contribute too much to the account. If you are in a position to do so, it might be worth it to max out your contribution amount for both the IRA and the HSA for the previous year.

Opening a new account can provide you with benefits beyond the tax deduction. It’s important that you consider these benefits, since the tax benefit you receive will not be equal — in dollar amounts — to what you contribute to these accounts.

Your IRA will help you save up, tax-deferred, for the future, helping you create a nest egg. A HSA can help you save up money for health care expenses. In the future, you can set money aside in the HSA, receive your tax deduction, and then use the money in the account (many accounts come with a debit card) to cover your out of pocket expenses. It’s a great way to make more of your medical costs tax-deductible.

Figure out whether or not you could benefit from another tax deduction. Run the numbers in both scenarios, and find out whether or not it will work for you.

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{ 9 comments… read them below or add one }

Sun January 24, 2012 at 9:10 am

I tried to sign up for a HSA but you need a medical plan that has a $1200 or higher deductible. I missed it by $200. It also depends on your tax bracket whether these tax shelters make financial sense . If you don’t pay taxes or pay 15% it is less of an incentive than those that pay 35%.

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Patrick R. Carlson January 25, 2012 at 9:53 am

You are absolutely right. The deductions aren’t worth as much to someone in s a lower marginal tax bracket.

The HSAs are generally less available because of the legal requirement that you be enrolled in a high deductible health plan. But the IRA option is pretty much open to everyone.

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Patrick R. Carlson January 25, 2012 at 10:05 am

These prior year deductions can be a great way to do some tax planning after the year is over.

Additionally, self employed individuals can use a SEP IRA to get an even bigger deduction (because the contribution limits are higher than for “regular” IRAs), if they have the cash to make the contribution.

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Marbella January 26, 2012 at 5:19 am

There were some great tax deductions, but I always say that you must plan your taxes before the year starts and not when it is time to declare. A good tax planning often extends over several years with great discounts.

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Paul February 16, 2012 at 1:16 pm

OK, so I had a high-deductible insurance plan in 2011, but I didn’t sign up for an HSA in 2011. Now, in Feb 2012, can I open a new HSA, and contribute to it for 2011, and deduct that amount off my 2011 taxes?

I’m asking because my HSA’s customer service people told me I cannot do this. They said, in order to contribute for the 2011 tax year, the HSA account has to have been opened before Jan 1. 2012. (I’m not at all sure they really know if this is correct.)

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Miranda February 16, 2012 at 2:32 pm

I don’t know why that would be. I have looked, but can’t find anything that restricts your prior contributions based on when you opened the HSA. Unless there is some other reason you weren’t eligible for a HSA in 2011, and are eligible now. But, I’m not a tax professional. You might want to call a tax professional to get his or her view.

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Paul March 1, 2012 at 9:58 am

OK, so I got a response from the IRS on this, and they said I cannot contribute for the 2011 tax year if the HSA is not established in 2011. They referred me to the following IRS bulletin:
http://www.irs.gov/irb/2008-29_IRB/ar11.html#d0e1302

Specifically Q-39:
Q-39. May a trustee treat an HSA as established before the date of establishment determined under state law, such as the date when HDHP coverage began?
A-39. No. But see Q&A-40 and Q&A-41 of this notice concerning the establishment date for HSAs in connection with rollovers, or where a previous HSA was established.

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Sambusa A April 4, 2012 at 1:49 pm

So, we’re saying that if I contribute the max amount now (assume it’s $5,000) from my after tax savings, I will reduce my previous year’s AGI, and when I withdraw this money in the future, it’ll get taxed again.

I know the rates/returns will determine the +/- of this, but isn’t this a benefit in the short run but essentially a zero sum game in the long run, particularly since the after tax savings I’m contributing will be treated as pre-tax and taxed again?

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david hilton June 4, 2012 at 8:14 am

Yes, contributing to an IRA could probably help you lower last year’s taxes a little bit, but it will certainly cause your future year taxes to increase a lot, especially for investments made this year. And your article is irresponsible to leave out this important point.

All the capital gains realized by your IRA will be taxed as regular income – NOT as capital gains. With capital gains now taxed at 15%, you will certainly be paying far more for the income you may realize from your new IRA than you would if you just invested that income in a non-IRA manner.

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