In another round of extensions, the IRS recently pushed back the deadline for contributing to individual retirement accounts (IRAs) to May 17—the same day as the income tax deadline. This means that you now have an additional month to build up your retirement nest egg and potentially reduce your overall taxable income, which could lead to a fair amount of savings.
The IRA extension applies to both traditional and Roth IRAs and comes with a $6,000 contribution limit for those who are under 50 years of age. If you’re over 50, you are allowed what they call a catch-up contribution in the amount of $1,000, for a total of $7,000.
Making a last-minute, one-time contribution near the deadline allows you to ease your tax burden. Let’s say you’re on the cusp of a higher tax bracket or looking for ways to decrease what you owe in taxes (or increase your refund!), you can make a tax-deductible contribution straight into your IRA account and shave money right off the top of your taxable income.
For example, if you fall into the 24% tax bracket and max out your annual contribution, you will reduce your federal income tax bill by $1,440; taxpayers in the 32% tax bracket will save $1,920 off of your tax bill, and so on…
Keep in mind, you will still need to pay tax on this income down the road. However, it won’t apply until you take distributions from your IRA when your income will most likely be less and fall into a lower tax bracket.
While anyone with earned income can open up an IRA account, there are other rules that apply to the deductibility for individuals who have both an employer-sponsored 401(k) account and an IRA. If your modified adjusted gross income (MAGI) is higher than $75,000 for individuals ($124,000 married filing jointly), you cannot deduct any of your IRA contributions. If your MAGI is less than $65,000 for individuals ($104,000 married filing jointly), you can deduct the full amount. Partial deductibility applies in the space between and whether one or both spouses contribute to an employer-sponsored plan.
If 2020 shifted you into a lower tax bracket than you anticipate in retirement, you may be better positioned to contribute to a Roth IRA before May 17. With a Roth IRA, your account is funded after taxes and grows tax free, so when you go to take distributions at the age of 59 ½, you pay zero taxes on the money you take out.
Small business owners or freelancers who hold retirement funds in other types of IRAs, such as a SEP IRA, can also take advantage of last-minute contributions before the deadline. SEP IRAs have a much larger limit than a traditional or Roth IRA and can be the lesser of 25% of total compensation or $57,000 for 2020 (and subject to annual cost-of-living adjustments for later years).
This extra month extension may be just what small business owners and self-employed freelancers need to get back on track after a tumultuous year. It took a significant amount of time for business owners to shift gears and reinvent their business model to adapt in a pandemic and may now just be catching up. And as jarring as it may seem, some businesses have still not been able to open as a result of government regulations.
The IRS also extended contributions to the following savings accounts to May 17, 2021 as well:
- Health savings accounts (HSA)
- Archer medical savings accounts
- Coverdell education savings accounts
If you’re looking for guidance on how to best approach your tax situation this year or how to fund your retirement account, my background as a CPA and financial advisor will give you clarity and the tools you need to make informed, strategic decisions in your financial life.
Contact me at stu@erocktax.com to start a conversation.
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About Stu: With more than 30 years of experience as a tax professional, Stu Steinberg brings a broad depth of knowledge to his work with his clients. Stu founded Erock Tax to help provide tax and financial planning strategies to individuals, families and small businesses and is passionate about empowering his clients through education about their money health. Stu is highly energetic and brings a sense of optimism, creative problem-solving and a deep level of commitment to every Erock client.