Does Changing How Much You Contribute to a Simple IRA Affect Your Tax Rate?
Changing the amount you contribute to your employer sponsored SIMPLE IRA plan will definitely change the amount of taxes you pay. Whether your actual tax rate changes depends on your total income, how much you contribute to the SIMPLE IRA and what tax rate is of most interest.
SIMPLE IRA Contributions
A SIMPLE IRA plan will be offered by your employer to let you make salary deferral contributions into an IRA account in your name. The contributions you choose to make come out of your wages before tax. You can contribute up to a maximum of $12,000 per year -- 2013 limit -- or $14,500 if you are over age 50. Your employer must also make a specified level of contributions into your associated IRA.
Payroll Tax Rate
If you increase or decrease the amount coming out of your paycheck to go into your SIMPLE IRA, the amount of taxes withheld from your paycheck will change. So increasing your IRA deferral will lower the rate of tax deductions from your wages. For example, using the Bankrate.com payroll deductions calculator, starting with $4,000 in salary and single withholding, increasing SIMPLE IRA contributions from zero to $400 reduces federal tax withholding by $60 per month.
Total Annual Taxes
Since SIMPLE IRA contributions are before-tax deferrals from your salary, your total tax bill for the year will be lower if you increase your contributions. For example, if you are in a combined 30 percent tax bracket and contribute $6,000 to the SIMPLE IRA, your total taxes will be $1,800 lower with the contributions compared to not putting money in the SIMPLE IRA account. How much you actually save depends on your combined federal and state tax brackets.
Marginal Income Tax Rate
The tax code has different tax rates with higher percentages as your income increases. The highest rate you pay on your last dollar of income is your marginal income tax rate or your tax bracket. If you contribute enough to your SIMPLE IRA to reduce your taxable income below the income level where a tax bracket starts, the contributions could actually change your personal tax bracket. You can see if you are near a lower tax bracket by comparing your taxable income for last year to the current, in-effect tax rates by income level.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.