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Suppose my salary for the year is $1000. My tax bracket is 10%, thus my employer has withheld $100 and I only ever get to see $900.

Question #1: I would like to put everything I earned ($1000) into a traditional IRA. Since you put "pre-tax" dollars into a traditional IRA, I should be able to contribute all $1000 to my IRA. But how can I if I only ever get to see $900?

Question #2: Suppose I only contribute $900 to my traditional IRA for the year. Is my Adjusted Gross Income now $100 (i.e. $1000 - $900)? Does this mean my income tax is $10 (10% bracket) and I should get a $90 tax refund? Yet, this seems unfair that I owe any tax at all, when I didn't see any real income at all because the $100 was withheld by my employer all year. Is this really how it works?

Question #3: Suppose I get a $90 tax refund. This refund is "after tax" right? That is, taxes have already been paid on that income (the $10), and $90 is what I got to keep after taxes albeit in the form of a refund. If I now go put this $90 into a traditional IRA, then when I withdraw from my IRA later on, will it get taxed again?

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    Hi Ray. Welcome to the site. I don't think this is necessarily a bad question. I suspect the downvotes are mainly due to the title and the tone taken regarding fairness. It's best to approach this type of topic without emotions, and just focus on the math. – TTT Apr 27 '16 at 3:33
  • @TTT - part of the issue is the contrived nature of the question makes it harder to answer. e.g. We have a $10K combined exemption and std deduction. Aside from FICA, no tax would be held, as no tax is due on 1K. When you bump to $11K, you deposit $1K to the IRA and these issue go away, adjust W-4, and done. (And no answer suggested going to Roth.) – JoeTaxpayer Apr 27 '16 at 10:27
  • @JoeTaxpayer - I completely agree with you. And actually I did mention Roth in my answer. – TTT Apr 27 '16 at 17:59
  • oops, I skimmed too quickly. Just +1 your answer, good points all of them. – JoeTaxpayer Apr 27 '16 at 18:22
  • I don't think Roth is germane, since the question seems clearly to be about how contributions will affect your taxes. Contributions to Roth will have no effect on your income tax. – BrenBarn Apr 27 '16 at 19:05
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Suppose my salary for the year is $1000. My tax bracket is 10%, thus my employer has withheld $100 and I only ever get to see $900.

I'm going to just pretend these assumptions are compatible and answer theoretically, glossing over the details of what would actually happen if you actually earned only $1000 in a year. In reality, if you made only $1000 per year you would not owe any tax.

Question #1: I would like to put everything I earned ($1000) into a traditional IRA. Since you put "pre-tax" dollars into a traditional IRA, I should be able to contribute all $1000 to my IRA. But how can I if I only ever get to see $900?

You could file a W-4 with your employer, claiming extra exemptions to reduce your withholding. If you plan on claiming adjustments to income (such as IRA contributions) that would substantially reduce your income, you could in theory reduce your tax withholding to zero.

You can also do as you asked about in your Question #2: contribute your $900. Your tax liability will and you'll get a refund of the tax that was withheld (or part of it, depending on how much income you still had after your IRA contribution).

Question #2: Suppose I only contribute $900 to my traditional IRA for the year. Is my Adjusted Gross Income now $100 (i.e. $1000 - $900)? Does this mean my income tax is $10 (10% bracket) and I should get a $90 tax refund? Yet, this seems unfair that I owe any tax at all, when I didn't see any real income at all because the $100 was withheld by my employer all year. Is this really how it works?

Imagine the money had not been withheld, and you had received the $100 in cash. You would then owe $10 in taxes, leaving you with $90, which is the same amount you got from your refund. Either way you wind up with $90.

It is true that you cannot contribute the whole $1000 because some is withheld. You can get around that by increasing your allowances with a W-4 as I explained above.

Question #3: Suppose I get a $90 tax refund. This refund is "after tax" right? That is, taxes have already been paid on that income (the $10), and $90 is what I got to keep after taxes albeit in the form of a refund. If I now go put this $90 into a traditional IRA, then when I withdraw from my IRA later on, will it get taxed again?

Withdrawals from a traditional IRA are taxed as ordinary income, so yes, you will pay taxes on it when you take it out. However, in the year that you put it into your IRA, you will lower your taxable income by $90, reducing your tax in that year.

For instance, suppose that in the year 2016 you earn $1000, contribute $900 to your IRA, and get a $90 refund, as you described above. Then suppose that in 2017 you again earn $1000, but now you contribute the $90 from last year's refund to your IRA. Since the refund doesn't count as taxable income, you taxable income in 2017 is only 1000-90=$910, although you actually earned $1000. This means you'll only owe $91 in taxes, not $100. So, although you will pay taxes on the $90 when you take it out, it saved you money on your taxes in 2017, when you put it into the IRA.

In practice, you will never be able to get things to work out so that you end every year with the exactly correct amount of tax having been withheld. You will always either get a small refund or owe a small amount of extra tax (or, even worse, get a large refund, or even worse, owe a large amount of extra tax). You can't expect your tax payments and refunds to completely balance out over any fixed number of years. Inevitably, there will be a slight mismatch which will carry into future years. In theory, you won't lose any money due to this sort of juggling. (In practice, you may lose money, but it won't be due to the juggling per se; rather, you can lose money due to being in different tax brackets at unfavorable times, or due to changes in tax law that come at unfavorable times.)

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    After tax contributions are not actually taxed on withdrawal, they're added to the IRA basis. – littleadv Apr 27 '16 at 8:27
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    If he files for the refund early enough he can put the entire $1000 into the IRA because he can actually make the deposit after he files the tax forms and before April 15th. – mhoran_psprep Apr 27 '16 at 10:08
  • @mhoran_psprep - I was thinking the same thing, but then I decided against it because at the time you file, your return would actually be false. Is that legal? – TTT Apr 27 '16 at 18:51
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    Yes it is legal. Turbo tax asks if you intend to make the deposit by tax day. In face mnay people make a habit of using their refund this way. – mhoran_psprep Apr 27 '16 at 22:40
  • @littleadv: The question doesn't seem to actually be actually talking about after-tax (i.e., non-deductible) IRA contributions. He's talking about making contributions to lower his taxable income. – BrenBarn Apr 28 '16 at 1:51
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I think your question is overly simple. It ignores some important basic concepts...

  1. Someone earning only $1,000 would not be subject to income tax, you'd get 100% of any withholding back at tax time, knowing this, you could save yourself trouble and put "Exempt" on your W4.
  2. assuming you were using that number for simplicity, the same principle applies...

Any contributions you make to your IRA would be tax deductible (assuming your not participating in an employer sponsored retirement plan) up to certain annual limits set by the government. If your income is less than that limit and you were not subject to state / local taxes, you could (theoretically) put all of your money into your IT'S simply by having your employer not withhold taxes from your check (as previously explained).

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For simplicity, I'll skip discussing social security, medicare, and any other tax credits you may have, and just answer your questions based on your numbers.

  1. Some employers offer pre-tax plans such as a 401K so that you can avoid the scenario you're describing, but assuming the traditional IRA is your only option, then if you borrowed $100 from someone, you could put $1000 into the IRA and get the $100 you paid in taxes back as a refund. If you are unable to borrow the $100 you would be in the scenario you described in question 2:
  2. You are correct, your refund would be $90. As for fairness, in this scenario you took home $900 to do with whatever you'd like, and you chose to put that $900 into an IRA so that you could save an additional $90.
  3. Once again you are correct. However, when you put that $90 into your IRA, you will be able to deduct it from your income for the next year, so you will save the tax on that $90, which would be $9 savings if you are still in the 10% bracket.

As a side note, you can chose to put your money into a Roth IRA instead of a Traditional IRA. In a Roth, you put in after tax money but you never have to pay taxes on the growth or distributions once you reach retirement age. If you are in the 10% tax bracket, it may be beneficial to pay the 10% tax now, and not have to pay taxes when you retire, since you may be in a higher tax bracket when you're older. I'm not sure if I'd go as far as calling this a rule of thumb, but it could be the case that if you're in a low tax bracket, lean towards the roth IRA, and if you're in a high tax bracket, lean towards the traditional IRA.

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    ..and if he really is in the 0% tax bracket, then a Roth IRA or Roth 401K can make a lot of sense. By paying that 0% tax on that money before putting it into a Roth he can receive a ton of tax free growth for decades. – mhoran_psprep Apr 27 '16 at 10:04
  • @mhoran_psprep - agreed! – TTT Apr 27 '16 at 17:56

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