Saving now for retirement is one of the best moves you can make.
If you’re getting ready to file your 2020 tax return and your tax bill is higher than you’d like, you may have an opportunity to reduce it. If you qualify, you can make a tax-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’s eligible?
You can make a deductible contribution to a traditional IRA if:
You (and your spouse) do not participate in an employer-sponsored retirement plan.
OR
You (or your spouse) participate in an employer plan, but your modified adjusted gross income (AGI) does not exceed certain levels, which vary from year-to-year by filing status.
For 2020, the maximum modified AGI is:
$104,000 to $124,000 for joint tax filers
$65,000 to $75,000 for single and head of household filers
$0 to $10,000 for married filing separately
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 between $196,000 and $206,000.
Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax deferred. But every dollar you take out is taxed in full and subject to a 10 percent 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 have until April 15 to make a Roth IRA contribution as well. But while contributions to a traditional IRA are deductible, those to a Roth IRA are not. The tradeoff is that withdrawals from a Roth IRA are tax-free when the account has been open at least five years and you’re age 59 1/2 or older. There are income limits to contribute to a Roth IRA.
Two other IRA strategies that may help you save tax include:
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. The contribution isn’t deductible, however. If you realize you need the deduction a traditional IRA contribution provides, you can change your mind and turn a Roth IRA contribution into a traditional IRA contribution using 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. You generally can’t make a deductible traditional IRA contribution unless you have wages or other earned income. 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?
If you’re eligible for 2020, you can make a deductible traditional IRA contribution of up to $6,000—or $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 you can contribute to a SEP is $57,000.
If you want to learn more 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.