Your tax bracket can affect your life in many ways. It can affect how much overtime you choose to work. It can affect how much money you choose to give away to charity. It can also affect how much money you choose to put away for your retirement in the form of IRA contributions.
In many cases, making contributions to an IRA can reduce your tax liability. If you are just barely in the tax bracket that you are in, it creates an opportunity for you to keep your money safe from the IRS, at least temporarily, while it is accumulating interest and helping you toward having money to retire with. Often, by the time you take out the funds from your IRA, your income is lower, putting you in a lower tax bracket and allowing you to pay less in taxes in the long run.
Of course, this loophole can sometimes work against those who do not have a very high income to begin with. When someone is in a low income tax bracket, where they pay little or nothing in income tax, they may decide not to make any IRA contributions at all. In the short term, this may allow them to have more income to cover their bills. However, over the long term, they will not have the savings that they need to retire.
There is also the issue that if they do put anything away in an IRA account, and defer taxes when there are essentially no taxes to defer, they may wind up paying income tax on it later if they are earning more when they withdraw it. As a result, they wind up in a catch 22. For these people, it may be better to put the money in a CD or other investment vehicle so that they still have the savings, but the taxes are not deferred.
The IRS defers taxes on contributions to IRA’s so that people can be encouraged to save for retirement. It is best to make sure that you do your homework when you are looking at IRA’s and invest in the ones that shelter you from taxes if you are in a position where you may be between tax brackets.
There are some limits on how much you can contribute without being liable for the taxes, and you will want to contribute the maximum amount without hurting yourself financially in the short term. If your income is not high enough to give you very much or gives your very little tax liability, do not worry about looking for a tax shelter IRA, but do try to save or invest as much as you can toward retirement.