If you’re getting ready to file your 2020 tax return, and your tax bill is higher than you’d like, there might still be an opportunity to lower it. If you qualify, you can make a deductible contribution to a traditional IRA right up until the April 15, 2021 filing date and benefit from the tax savings on your 2020 return.
Who is eligible?
You can make a deductible contribution to a traditional IRA if:
- You (and your spouse) aren’t an active participant in an employer-sponsored retirement plan, or
- You (or your spouse) are an active participant in an employer plan, but your modified adjusted gross income (AGI) doesn’t exceed certain levels that vary from year-to-year by filing status.
For 2020, if you’re a joint tax return filer and you are covered by an employer plan, your deductible IRA contribution phases out over $104,000 to $124,000 of modified AGI. If you’re single or a head of household, the phaseout range is $65,000 to $75,000 for 2020. For married filing separately, the phaseout range is $0 to $10,000. For 2020, if you’re not an active participant in an employer-sponsored retirement plan, but your spouse is, your deductible IRA contribution phases out with modified AGI of between $196,000 and $206,000.
Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax deferred. However, every dollar you take out is taxed in full (and subject to a 10% penalty before age 59 1/2, unless one of several exceptions apply).
IRAs often are referred to as “traditional IRAs” to differentiate them from Roth IRAs. You also have until April 15 to make a Roth IRA contribution. But while contributions to a traditional IRA are deductible, contributions to a Roth IRA aren’t. However, withdrawals from a Roth IRA are tax-free as long as the account has been open at least five years and you’re age 59 1/2 or older. (There are also income limits to contribute to a Roth IRA.)
Here are two other IRA strategies that may help you save tax.
1. Turn a nondeductible Roth IRA contribution into a deductible IRA contribution. Did you make a Roth IRA contribution in 2020? That may help you in the future when you take tax-free payouts from the account. However, the contribution isn’t deductible. If you realize you need the deduction that a traditional IRA contribution provides, you can change your mind and turn a Roth IRA contribution into a traditional IRA contribution via the “recharacterization” mechanism. The traditional IRA deduction is then yours if you meet the requirements described above.
2. Make a deductible IRA contribution, even if you don’t work. In general, you can’t make a deductible traditional IRA contribution unless you have wages or other earned income. However, an exception applies if your spouse is the breadwinner and you are a homemaker. In this case, you may be able to take advantage of a spousal IRA.
What’s the contribution limit?
For 2020 if you’re eligible, you can make a deductible traditional IRA contribution of up to $6,000 ($7,000 if you’re 50 or over).
In addition, small business owners can set up and contribute to a Simplified Employee Pension (SEP) plan up until the due date for their returns, including extensions. For 2020, the maximum contribution you can make to a SEP is $57,000.
If you want more information about IRAs or SEPs, contact us or ask about it when we’re preparing your return. We can help you save the maximum tax-advantaged amount for retirement.
© 2021 Covenant CPA
Do you want to save more for retirement on a tax-favored basis? If so, and if you qualify, you can make a deductible traditional IRA contribution for the 2018 tax year between now and the tax filing deadline and claim the write-off on your 2018 return. Or you can contribute to a Roth IRA and avoid paying taxes on future withdrawals.
You can potentially make a contribution of up to $5,500 (or $6,500 if you were age 50 or older as of December 31, 2018). If you’re married, your spouse can potentially do the same, thereby doubling your tax benefits.
The deadline for 2018 traditional and Roth contributions for most taxpayers is April 15, 2019 (April 17 for those in Maine and Massachusetts).
There are some ground rules. You must have enough 2018 earned income (from jobs, self-employment or alimony) to equal or exceed your IRA contributions for the tax year. If you’re married, either spouse can provide the necessary earned income. And you can’t make a deductible contribution to a traditional IRA if you were 70½ or older as of December 31, 2018. (But you can make one to a Roth IRA after that age.)
Finally, deductible IRA contributions are phased out (reduced or eliminated) if last year’s modified adjusted gross income (MAGI) is too high.
Types of contributions
If you haven’t already maxed out your 2018 IRA contribution limit, consider making one of these three types of contributions by the April deadline:
1. Deductible traditional. With traditional IRAs, account growth is tax-deferred and distributions are subject to income tax. If you and your spouse don’t participate in an employer-sponsored plan such as a 401(k), the contribution is fully deductible on your 2018 tax return. If you or your spouse doparticipate in an employer-sponsored plan, your deduction is subject to the following MAGI phaseout:
- For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan:
- For a spouse who participated in 2018: $101,000–$121,000.
- For a spouse who didn’t participate in 2018: $186,000–$196,000.
- For single and head-of-household taxpayers participating in an employer-sponsored plan: $63,000–$73,000.
Taxpayers with MAGIs within the applicable range can deduct a partial contribution. But those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.
2. Roth. Roth IRA contributions aren’t deductible, but qualified distributions — including growth — are tax-free, if you satisfy certain requirements.
Your ability to contribute, however, is subject to a MAGI-based phaseout:
- For married taxpayers filing jointly: $189,000–$199,000.
- For single and head-of-household taxpayers: $120,000–$135,000.
You can make a partial contribution if your 2018 MAGI is within the applicable range, but no contribution if it exceeds the top of the range.
3. Nondeductible traditional. If your income is too high for you to fully benefit from a deductible traditional or a Roth contribution, you may benefit from a nondeductible contribution to a traditional IRA. The account can still grow tax-deferred, and when you take qualified distributions, you’ll only be taxed on the growth.
Traditional and Roth IRAs provide a powerful way to save for retirement on a tax-advantaged basis. Contact us to learn more about making 2018 contributions and making the most of IRAs in 2019 and beyond. 205-345-9898 or email@example.com.
© 2019 CovenantCPA
Retirement plan contribution limits are indexed for inflation, and many have gone up for 2019, giving you opportunities to increase your retirement savings:
- Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans: $19,000 (up from $18,500)
- Contributions to defined contribution plans: $56,000 (up from $55,000)
- Contributions to SIMPLEs: $13,000 (up from $12,500)
- Contributions to IRAs: $6,000 (up from $5,500)
One exception is catch-up contributions for taxpayers age 50 or older, which remain at the same levels as for 2018:
- Catch-up contributions to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans: $6,000
- Catch-up contributions to SIMPLEs: $3,000
- Catch-up contributions to IRAs: $1,000
Keep in mind that additional factors may affect how much you’re allowed to contribute (or how much your employer can contribute on your behalf). For example, income-based limits may reduce or eliminate your ability to make Roth IRA contributions or to make deductible traditional IRA contributions.
For more on how to make the most of your tax-advantaged retirement-saving opportunities in 2019, please contact us at 205-345-9898.
© 2018 Covenant CPA
As the year winds to a close, most businesses see employees taking a lot of vacation time. After all, it’s the holiday season, and workers want to enjoy it. Some businesses, however, find themselves particularly short-staffed in December because they don’t allow unused paid time off (PTO) to be rolled over to the new year, or they allow only very limited rollovers.
There are good business reasons to limit PTO rollovers. Fortunately, there’s a way to reduce the year-end PTO vortex without having to allow unlimited rollovers: a PTO contribution arrangement.
Retirement saving with a twist
A PTO contribution arrangement allows employees with unused vacation hours to elect to convert them to retirement plan contributions. If the plan has a 401(k) feature, it can treat these amounts as a pretax benefit, similar to normal employee deferrals. Alternatively, the plan can treat the amounts as employer profit sharing, converting excess PTO amounts to employer contributions.
This can be appealing to any employees who end up with a lot of PTO left at the end of the year and don’t want to lose it. But it can be especially valued by employees who are concerned about their level of retirement saving or who simply value money more than time off of work.
Good for the business
Of course the biggest benefit to your business may simply be that it’s easier to ensure you have sufficient staffing at the end of the year. But you could reap that same benefit by allowing PTO rollovers (or, if you allow some rollover, increasing the rollover limit).
A PTO contribution arrangement can be a better option than increasing the number of days employees can roll over. Why? Larger rollover limits can result in employees building up large balances that create a significant liability on your books.
Also, a PTO contribution arrangement might help you improve recruiting and retention, because of its appeal to employees who want to save more for retirement or don’t care about having a lot of PTO.
Set-up is simple
To offer a PTO contribution arrangement, simply amend your retirement plan. However, you must still follow the plan document’s eligibility, vesting, rollover, distribution and loan terms. Additional rules apply.
Have questions about PTO contribution arrangements? Contact us at 205-345-9898. We can help you assess whether such an arrangement would make sense for your business.
© 2018 Covenant CPA
Will you be age 50 or older on December 31? Are you still working? Are you already contributing to your 401(k) plan or Savings Incentive Match Plan for Employees (SIMPLE) up to the regular annual limit? Then you may want to make “catch-up” contributions by the end of the year. Increasing your retirement plan contributions can be particularly advantageous if your itemized deductions for 2018 will be smaller than in the past because of changes under the Tax Cuts and Jobs Act (TCJA).
Catch-up contributions are additional contributions beyond the regular annual limits that can be made to certain retirement accounts. They were designed to help taxpayers who didn’t save much for retirement earlier in their careers to “catch up.” But there’s no rule that limits catch-up contributions to such taxpayers.
So catch-up contributions can be a great option for anyone who is old enough to be eligible, has been maxing out their regular contribution limit and has sufficient earned income to contribute more. The contributions are generally pretax (except in the case of Roth accounts), so they can reduce your taxable income for the year.
More benefits now?
This additional reduction to taxable income might be especially beneficial in 2018 if in the past you had significant itemized deductions that now will be reduced or eliminated by the TCJA. For example, the TCJA eliminates miscellaneous itemized deductions subject to the 2% of adjusted gross income floor — such as unreimbursed employee expenses (including home-off expenses) and certain professional and investment fees.
If, say, in 2018 you have $5,000 of expenses that in the past would have qualified as miscellaneous itemized deductions, an additional $5,000 catch-up contribution can make up for the loss of those deductions. Plus, you benefit from adding to your retirement nest egg and potential tax-deferred growth.
Other deductions that are reduced or eliminated include state and local taxes, mortgage and home equity interest expenses, casualty and theft losses, and moving expenses. If these changes affect you, catch-up contributions can help make up for your reduced deductions.
2018 contribution limits
Under 2018 401(k) limits, if you’re age 50 or older and you have reached the $18,500 maximum limit for all employees, you can contribute an extra $6,000, for a total of $24,500. If your employer offers a SIMPLE instead, your regular contribution maxes out at $12,500 in 2018. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $15,500 in total for the year.
But, check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do. Also keep in mind that additional rules and limits apply.
Catch-up contributions are also available for IRAs, but the deadline for 2018 contributions is later: April 15, 2019. And whether your traditional IRA contributions will be deductible depends on your income and whether you or your spouse participates in an employer-sponsored retirement plan. Please contact us at 205-345-9898 for more information about catch-up contributions and other year-end tax planning strategies.
© 2018 Covenant CPA