Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but this does not affect the opinions or ratings of our editors.
You now have an additional month to reduce your tax bill by contributing to your Individual Retirement Account (IRA).
Just like last year, the IRS has 2020 tax filing deadline extension to May 17, giving Americans an extra month to make IRA contributions that can potentially ease their IOUs to Uncle Sam while also helping them save for their retirement.
But are these contributions the best way for you to save for retirement? And just because you can actually go back in time to lower your tax bill, right?
How To Reduce Your Taxable Income With IRA Contributions
First of all, a few Basics of IRA Contributions. Each year, you can contribute a total of $ 6,000, or $ 7,000 if you are 50 or over, into your individual retirement accounts.
With a traditional IRA, you can usually deduct any contributions you make from your taxable income now. The investments you buy with that money then increase tax-free until you start making withdrawals after age 59 and a half, when you pay taxes on whatever you withdraw (the Roth IRAs are different, but more on that in a second).
Traditional IRA contributions can save you a decent amount of money on your taxes. If you are in the 32% tax bracket, for example, contributing $ 6,000 to an IRA would reduce your tax bill by $ 1,920. This not only helps you reduce your current tax burden, but is also a strong incentive to build up your retirement nest egg.
You have until Tax Day, usually April 15 of the following year, to make IRA contributions (and therefore also reduce your taxable income).
Note: If you have access to other types of ARI, such as a SEP IRA, you can also make last-minute contributions. SEP IRAs, which are designed for small businesses or the self-employed, offer contribution limits almost 10 times greater than normal IRA limits, and you can contribute to both a SEP IRA and a personal IRA. You can even file an extension and get until October 15, 2021 to make a 2020 SEP IRA contribution, giving you almost 10 months to reduce your taxes for the previous year.
How To Get A Tax Deduction With IRA Contributions
Anyone with earned income can open a traditional IRA, contribute maximum, and benefit from tax-deferred investment growth. But there are strict rules about who is eligible for contribution tax deductions that can reduce your income tax.
Anyone not covered by a defined contribution plan in the workplace, such as a 401 (k), can deduct all of their traditional IRA contributions from their taxes. It’s a bit more complicated if you and / or your spouse are covered by a workplace pension plan.
If you are a single registrant in this situation:
• You can fully deduct all of your IRA contributions from your taxes if your modified adjusted gross income (MAGI) is $ 65,000 or less
• Partially deduct your IRA contributions if your MAGI is between $ 65,000 and $ 75,000
• You cannot deduct any of your IRA contributions if your MAGI is greater than $ 75,000
For married households jointly reporting households where both spouses have a 401 (k):
• You can fully deduct all of your IRA contributions if your MAGI is $ 104,000 or less
• Partially deduct your IRA contributions if your MAGI is between $ 104,000 and $ 124,000
• You cannot deduct any of your IRA contributions if your MAGI is greater than $ 124,000
For married persons jointly declaring households where your spouse has a 401 (k) but you do not:
• You can fully deduct your IRA contributions if your MAGI is $ 196,000 or less
• Partially deduct your IRA contributions if your MAGI is between $ 196,000 and $ 206,000
• You cannot deduct IRA contributions if your MAGI is greater than $ 206,000
Does a Last Minute IRA Contribution Make Sense to You?
Just because you can make one of these last minute IRA contributions doesn’t mean you necessarily have to.
If you have a high income and are entitled to a full or partial deduction, it may be a good idea to get a contribution under the transfer. Of all the retirement taxes available to you for the previous year, you might benefit the most.
What if you’re not in one of the highest tax brackets right now? You can certainly still contribute to a traditional IRA, but your deduction might not be that big. A person in the 12% tax bracket, for example, could save just $ 720. Nothing to sneeze, of course. But you might actually get better tax benefits in the long run from something called a Roth IRA instead of.
Roth IRAs can save you a lot of taxes down the road
A Roth IRA is funded with dollars that Uncle Sam once wrath. That means no initial tax deduction (and no decrease in your taxable income now), but you never have to pay a dime on it. eligible withdrawals made after the age of 59 and a half.
If you are currently in a lower tax bracket, you could save up to double the taxes you would have to pay later if you move to a higher tax bracket in retirement, assuming you have moved from 10% or 12% to any other tax bracket. of the other brackets. That’s why a Roth IRA makes a lot of sense to young earners who are in a lower tax bracket today than they’ll see once they hang up their boots.
In fact, anyone who is able to contribute to a Roth now can benefit in the long run. “If you’re eligible for a Roth IRA, you’re probably better off paying taxes now,” says Tony Molina, CPA of Wealthfront. “We are in a period of historically low tax rates.
Unfortunately, not everyone can contribute to a Roth IRA. Much like the traditional IRA tax deduction limits we covered earlier, there are income thresholds that put the Roth IRA out of reach for high earners. Single tax filers earning less than $ 125,000 in 2021 can contribute up to $ 6,000, or $ 7,000 if you’re 50 or older, while those earning between $ 125,000 and $ 139,999 can save a reduced amount. . If your income is over $ 140,000, you’re out of luck.
While Roth contributions today won’t lower your taxes today, there is more to retirement savings strategies than saving a few dollars on your tax bill right now.
When a traditional IRA makes more sense for low incomes
Still, there may be scenarios where it makes sense for those without the highest incomes to use a traditional IRA.
To see if these might be right for you, start by preparing your 2020 tax return to determine your adjusted gross income. Once you have that number in hand, you can see if you’re about to qualify for an income-based tax deduction, says Mike Piper, a Chartered Accountant (CPA) based in St. Louis, which would make using an IRA traditional. more attractive to save a lot more money here and now.
You might even get a tax break you’ve never heard of, like the saver credit, which less than half of taxpayers know about, but could credit you up to $ 2,000.
How would contributing to an IRA help you qualify?
Well, the amount of credit depends on your specifics, but married couples jointly filing with an AGI between $ 43,001 and $ 66,000 receive a credit worth 10% of their contribution (up to $ 2,000) on a retirement account. If this couple even made $ 66,001 in 2020, however, they wouldn’t get anything.
But if they pay $ 4,000 to an IRA, they could not only reduce their potential income tax by $ 480, but they would also reduce their AGI enough to qualify for a $ 400 savings credit bonus. .
While you may not get additional tax relief by making a last-minute contribution for 2020, by going through the steps to determine the deductions and IRAs you might take now, you will be able to take full advantage of the year. imposition next.