Like many Americans preparing to file their 2020 taxes, you are likely trying to gather as many documents and receipts as you can that will help you lower your tax obligation, increase your refund, or even help you to avoid any penalty fees. What many taxpayers forget to consider is the full impact of their investments and how they can be leveraged to mitigate tax liabilities now and in the future. With this in mind, we’ve compiled these three financially savvy investment tips you may want to take advantage of before the April 15th deadline.
1. Consider a Roth IRA Contribution or Conversion
A Roth IRA is a tax-advantaged savings vehicle that offers many benefits, including the ability to make contributions up until the April 15th tax deadline (for the previous year). This means that there is still time to boost your savings for the 2020 tax year. For 2020, the contribution limit for either a traditional IRA or Roth IRA is $6,000 (or $7,000 if you are age 50 or older). So if you haven’t reached the limit yet and are eligible (see below), schedule a contribution before you file your taxes.
Keep in mind that a Roth IRA is funded with after-tax dollars. This means that you pay taxes on contributed funds now to enjoy tax-free withdrawals in retirement. This is great news for your future tax liability even if you don’t anticipate having a higher income in retirement due to possible rising tax rates over time. Roth IRAs also don’t have any required minimum distributions, which means you can leave your money invested as long as you need without penalty.
But, there is a catch—Roth IRAs have income limits. The IRS has imposed income limits on Roth IRAs to determine who is eligible to contribute. Married couples filing jointly must have a modified gross adjusted income (MAGI) less than or equal to $196,000 to qualify. If your MAGI is between $196,000 and $206,000, you can still contribute a partial amount, but if you make over $206,000, you are not eligible at all.
However, high-income earners can still make contributions through what is called a backdoor Roth IRA. Because the IRS does not have any set income restrictions for converting a traditional IRA into a Roth IRA, a backdoor Roth IRA is a legal way to still take advantage of a Roth’s benefits. There are no limits on backdoor conversions so you can use this for as much saving as you need. Just keep in mind that you will still have to pay the taxes on the amount you convert as well as on interest that accrues while it is in the traditional IRA.
2. Contribute on Behalf of your Non-Working Spouse
Without an employer, a non-working spouse is often at a disadvantage when it comes to saving for retirement. They do not have access to the same retirement savings accounts or benefits (including an employer match) as one would through an employer. Luckily, the IRS has special contribution rules that allow contributions to be made to an IRA or Roth IRA for the non-working spouse based on the working spouse’s income.
Let’s take a look at an example. A stay-at-home wife without an income can make contributions up to her age-based limit based on her husband’s income. If she is under age fifty, she can contribute $6,000 per year. If she is over 50, that number jumps to $7,000 (even if her husband is under 50 and is limited to $6,000).
Keep in mind that in order to take advantage of this strategy, though, the couple must file a joint tax return. And, again, this contribution can be made between Jan. 1 and April 15 and still count toward the previous year. This is a great way to build a retirement savings for your non-working spouse and receive the tax benefit, either now with a traditional IRA contribution or later with a Roth IRA contribution.
3. Understand Contribution Rules to Avoid Error
As you can tell, you must meet certain requirements in order to be eligible to make contributions to IRAs and Roth IRAs. Failure to comply could result in double taxation and/or excise tax being owed to the IRS. These penalties can easily nullify your tax savings if you don’t follow all of the contribution rules.
The most frequently misunderstood rule is that the annual limit includes both traditional IRA and Roth IRA contributions. This means that you can contribute a total of $6,000 in one of three ways:
- Contribute the full $6,000 to a traditional IRA
- Contribute the full $6,000 to a Roth IRA
- Split the contribution between a traditional IRA and Roth IRA but not go over $6,000 in combined contributions
Additionally, you cannot contribute more than you earn, so if you made less than $6,000 in a year, you can only contribute up to that amount. For example, if you made $2,500 in 2020, you cannot contribute more than $2,500.
If you made IRA contributions and did not meet the income and age requirements where applicable, the contributions must be corrected under the “return of excess contributions” procedures. Excess contributions and ineligible rollover amounts that are not corrected by the tax filing deadline are subject to a 6% excise tax for every year the amount remains in the IRA or Roth IRA.
Taking advantage of tax savings is a big part of a successful retirement plan. And it is certainly less stressful and costly to prevent errors over correcting them later on. If you need help understanding the rules and making sure you are contributing the most you can, contact our office today. We know that the longevity of your retirement income is partially dependent on how well you mitigate taxes, so we don’t take this issue lightly. Schedule a conversation with us today to learn more.
Disclaimer: Advisory services are offered through URS Advisory LLC, a Registered Investment Advisor in the State of Florida. Insurance products and services are offered through URS Insurance, an affiliated company. URS Advisory LLC and URS Insurance are not affiliated with or endorsed by the Social Security Administration or any government agency. Investing involves risk including the potential for loss, and past performance is no indication of future results. Opinions expressed herein are solely those of URS Advisory. All written content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your financial adviser or qualified professional before making any financial decisions.