Tax time is a great time to review your retirement savings to make sure you are maximizing your IRA retirement plan contributions. The IRS gives you until April 15 (Tax Day!) to make contributions for the preceding year (current tax year). That’s right! You can make contributions to your retirement account up until April 15th of the following year. However, this does not apply to most salary deferral retirement plans like 401(k)s and 403(b)s. For retirement accounts, such as 401(k)s and 403(b)s, the contribution deadline for the current year is December 31st.
If you did not maximize your IRA tax benefits for the current tax year, you still have time, if it is before the tax-filing deadline. This provides a great opportunity for taxpayers to see how contributing to their IRA retirement plan will affect their tax credits and benefits and take advantage of the IRA deduction for contributing to traditional IRAs and the Retirement Savings Contributions Credit (Saver’s Credit). Do not leave free money on the table!
If you contribute to a traditional IRA for the tax year, you are able to deduct that amount from your taxable income, called an IRA deduction, if you are eligible. There are limitations on income and the amount you can contribute, which you can read more about here. Roth IRAs do not qualify for this deduction because they are funded with after tax dollars, so you can get the tax benefits later. With traditional IRAs, if you are not above the income limits, you get the tax benefits now.
Example. Angela, 30 years old, earns $35,000 and contributes to her 401(k) through work. She maxed out her traditional IRA contribution of $6,000 for the tax year.
In the example above, if Angela had no other tax deductions, just her contribution to her traditional IRA alone would reduce her taxable income to $29,000 ($35,000 - $6,000). Because Angela falls in the 12% tax bracket, this saves her $720. Therefore, it only cost her $5,280 to save an additional $6,000 for her retirement.
If Angela’s income had been taxed at a higher rate, she could have saved even more money by contributing to her traditional IRA!
The Retirement Savings Contributions Credit is known as the Saver’s Credit. It provides moderate and low income taxpayers an additional tax credit for saving for retirement. The credit is either 50%, 20%, or 10% of your eligible retirement plan contributions up to $2,000, depending on your adjusted gross income. For 2020, it is eliminated for taxpayers with an adjusted gross income of $32,500 or more, if filing single; $48,750 or more, if filing head of household; or $65,000 or more, if filing married filing jointly.
Also, this tax credit is not refundable. If your tax liability is zero, your Saver’s Credit will be lost.
Example. Mark, 45 years old, earns $42,000 and contributes $4,000 to his traditional IRA for the year. He files married filing jointly. His adjusted gross income (AGI) is $38,000. His tax liability for the tax year is $1,400.
Because Mark’s AGI is below the threshold requirement for the 50% Saver’s Credit, he would qualify for up to $2,000 Saver’s Credit (50% x his traditional IRA contribution of $4,000). However, Mark only owes $1,400 in tax this year. The Saver’s Credit would wipe out Mark’s tax bill, which would mean he would owe $0 in taxes for the tax year. However, the remaining balance of the Saver’s Credit ($2,000 - $1,400) or $600 would be lost. This is because this tax credit is not refundable.
Tax time is a great time to make sure you are maximizing your retirement contributions. You have until the tax-filing deadline to contribute to your IRAs for the current tax year. Depending on your adjusted gross income and contributions to your retirement accounts, saving for retirement can be a win-win! Tax savings now and retirement income late!
Contact the tax professionals at Gudorf Tax Group to schedule an appointment to review how saving for retirement will affect your taxes, so you can make a wise decision to max out your retirement contributions and tax savings.