Do I benefit from contributing to my IRA if I have no tax liability?

[rachels]

I'm curious: For the past two years I have been living off of $3000-4000/year while making about $8000. Since I have no income tax liability to begin with, does it still benefit me tax-wise to make contributions to the traditional IRA I opened while earning more? Can I use my contributions to reduce the self-employment tax I need to pay next year?

[jacob]

I'm not really an expert (just someone who does his return with pen and paper), but ...
IRA contributions are above the line and wont reduce your self-employment tax. That gets tagged on almost at the very end. I don't know any easy way around that.
Do you benefit from the IRA ... it depends on what the regulations are/will be concerning dividend taxation and more precisely what you have in your IRA. So far capital gains and common dividends have not been taxed (but they may be if the Bush tax cuts aren't extended) for low income (in the 15% or less bracket). Hence, it wouldn't matter if they were held in an IRA or a broker account.
If the tax cuts expire, I think you'd be paying taxes on those regardless of whether your earned income stays low. The IRA would protect against that.
[I'd highly recommend doing the 1040 by hand. In 1-2 years, you'll really understand how it works. At long as you are not engaged in something crazy, the IRS publications are very clearly written (although the HSA one could use some work!) and one can learn a lot about the various brackets and limits.]

[Steve Austin]

Here's something I've seen suggested in various places: bundle your income. Jam two years worth of working into 1 year, to get your income above the standard deduction + personal exemption threshold, exploit the IRA contribution deduction (and the other credits that ERE has pointed out on the blog) and then take the year off from work and/or at least take the year off from contributing to the regular IRA. Or if you go crazy and have to work a low year, do a Roth IRA contribution that year (and probably still get the retirement contribution credit for low earned income folk).
I haven't been able to test this out myself yet. My income has alternated between very high and very low (zero). I need to figure my taxself out and finesse this much better. My finessing has been confined to zeroing out (federal income) tax on investment income.
Full concur with ERE and doing the 1040 by hand. Learn it by doing it. Exploiting tax holes is an entertaining game called Stick It Hard To The Man, Legally(tm). Okay, so I'm really just sticking it to US Taxpayers (including myself perhaps eventually) indirectly, but it's more fun to speak of The Man. Usually when I file the 1040, I do resort to the PDF fill-in form so I don't have to worry about (the IRS having) OCR problems when the return is processed.

[Matthew]

I would recommend putting the extra money in a Roth IRA. You don't get an immediate tax advantage, but like you said, you don't really need one at a low income. The Roth would let your money grow tax free and pull it out tax free because money that goes in a Roth has already been taxed (at your low rate).

[George the original one]

I'll second Matthew's suggestion. If you can't get a deduction for the IRA contribution, then it should go into a Roth.

[Robert Muir]

Another advantage to the Roth, besides all gains being free of income taxes, is that you can always withdraw your original contribution without penalty if you really need to.
I think a Roth is a no-brainer for anyone in a low income bracket who wants to save long-term.

[Kevin M]

The IRA isn't going to benefit you at those levels. I'd do the Roth. The only way to really reduce SE tax is additional business expenses, which isn't very ERE-like.

[rachels]

Thanks for the advice, my mother actually set up my traditional IRA for me when I graduated college, probably because she hoped I would be raking in the money soon. I have been considering opening a Roth or converting to a Roth.

[George the original one]

I don't know the details, but I'd be cautious on a Roth conversion as you may trigger the need to pay taxes. Just make future contributions to the Roth.

[Steve Austin]

In November/December of a given year, try to plan out how much your earned federal income plus bank account interest will be as of 31 December. Then subtract that estimate from 8750 (or whatever the sum of std deduction plus personal exemption is for the tax year) to determine how much of a tax-free regular-to-Roth IRA partial conversion you can arrange.

[Q]

Turbo Tax for me... although I did (almost) finish a tax class this summer... :/

[Kevin M]

Steve has a great planning point, but remember you can always re-characterize a Roth conversion by the extended due date of that year's return (October 15th) if you go over and create a tax liability.

[rachels]

Same goes for the supposed benefits of an HSA, I assume?