Published on 1/4/2021
The Internal Revenue Service has extended the tax filing deadline to May 17, effectively allowing another month for taxpayers to further lower their tax outgo by making contributions to their IRA accounts. The bid may not just save you some extra dollars – it will also add money to your retirement fund. However, there might be some fundamentals that you must be aware of when you choose IRA as your strategy for retirement as well as tax saving.
Contribute more to IRA to reduce your tax payout
The IRS lets you put $6,000 each year into your IRA accounts. Those over 50 years of age get an extra benefit of $1,000. The contribution you make to your traditional IRA accounts can be claimed when you file your taxes, i.e., it is a pre-tax contribution that you make. However, when you begin withdrawing that money from your IRA account, you will have to pay taxes to the Government. From another perspective, you are saving on tax now in your earning years, and putting more money in your IRA account which means a larger corpus for your retirement!
IRA contributions and tax deductions
The biggest advantage of having an IRA account and making regular contributions to it is that it allows tax-deferred growth for the money invested. You can also claim annual tax deductions on the amount you contributed to your IRA account.
If you are offered a retirement plan by your employer, claiming a tax exemption can get a little more tricky. Individuals can fully deduct the amount of IRA contribution from their taxes if their modified adjusted gross income is less than $65,000. Married or joint filers who have a 401(k) account each with a modified adjusted gross income of less than $104,000 too can deduct the full amount of IRA contribution. Individuals may partially deduct their IRA contributions if their modified adjusted gross income is between $65,000 and $75,000; the limit is between $104,000 and $124,000 for joint filers. However, individuals cannot claim any deduction if their modified adjusted gross income is over $75,000 or joint filers earn more than $124,000.
The bright side is that if either you or your spouse don’t have a 401(k) account, the deduction threshold increases. Joint filers in such cases, where one spouse has a 401(k) account but the partner does not, can fully deduct their IRA contributions if their joint modified adjusted gross income is less than $196,000. A partial deduction may be possible if the income is between $196,000 and $206,000, and no deduction is allowed beyond MAGI of $206,000
Last-minute IRA Contributions
Although the IRS has currently opened the provision to extend the window where you can possibly choose to make IRA contributions, it does not necessarily mean that you should do it.
If your modified adjusted gross income is within a higher taxable bracket, it may make all the sense to put some extra money into your IRA account as a last-minute tax-saving measure.
However, if you are not in one of the higher tax brackets, your last minute extra investment may not be as lucrative as some other investments. A Roth IRA may work better for you.
Better savings with a Roth IRA account
Roth IRA is funded with post-tax dollars, i.e., your contributions to your Roth IRA account have already been taxed. While this also means you cannot claim any further deduction on this money right now, you should know that this fund is not subject to any more taxes on qualified withdrawals once you turn 59.5 years old.
Roth IRAs make more sense for those who are not in a high-tax bracket right now but can climb up there in some time. By opting for Roth IRA accounts, you can potentially save a double of the taxes by paying the taxes in your more frugal years and enjoying a retirement with a tax-free larger corpus (against higher taxes on your high income and high taxes when you withdraw the large sum of money from your regular IRA account).
Having a Roth IRA account pays in the long term. Especially for youngsters who choose to have a Roth IRA account early on. The basis for this line of thought is – why not pay lower tax rates right now?
Nonetheless, much like the limits based on MAGI for regular IRAs, Roth IRAs have stringent rules that put this retirement product out of reach for high-income earners.
Traditional IRA account for those with low taxable incomes
While having a Roth IRA account has its advantages and may sound rosy, there are instances where having a regular IRA account makes more sense- especially for those with a lower taxable income.
Determine your gross adjusted income. Are you closer to the threshold of an income-based tax deduction? Then, a traditional IRA will be able to give you the much-required tax-breaks by helping you save tax here and now.
Also, do check out about saver’s credit that could credit you with up to $2,000 before you make your tax filing!
The bottom line being, taxpayers have at least a month to make more contributions to their IRA accounts and claim further tax deductions. Identifying if that is a good option for you or not is important. Write to us at C19grants@mytaxfiler.com with your queries.