What if I told you that there is a legal way to protect more of your hard-earned IRS money, and the government could actually reward you for taking advantage of it?
Well there is. If you have a little extra cash that you won’t need anytime soon, you can do a previous year Traditional IRA contribution and reap the benefits now and in retirement. Here’s a look at how it works and the difference it can make to your taxes.
What is an IRA contribution from the previous year?
An IRA contribution from the previous year is a contribution you make to your IRA for the previous year – in this case, 2020. You can do this anytime up to the April 15th tax filing deadline. although if you have already filed your taxes and then decide that you want to make a contribution from the previous year, you need to file an amended tax return, otherwise the government will not give you the tax break you deserve.
A traditional IRA contribution makes the most sense if you want tax relief this year, as these contributions reduce your taxable income. You can also put money in a Roth IRA if you prefer. These accounts are usually better if you think you are in a lower tax bracket than you will be in retirement. But you’re paying taxes on those contributions now in exchange for tax-free distributions later, so Roth IRA contributions won’t help you save money this year.
Making a contribution from the previous year is not much different from making an IRA contribution for the current year, although some IRA providers default to current year contributions, you may need to let your broker know. that you want your contribution to be applied to the 2020 tax year.
You should also make sure that your contribution does not exceed what you earned in income in 2020 or the contribution limit for the year, which is $ 6,000 (or $ 7,000 if you are 50 or older). Excess contributions could cause problems with the IRS. Only the income that you have earned from a regular job or from a side activity that you have declared to the government counts. Unemployment benefits do not.
How does a traditional IRA contribution save me money?
Traditional IRA contributions reduce your taxable income for the year. For example, if you made $ 44,000 in 2020 and put $ 5,000 into a traditional IRA, the federal government ignores that $ 5,000 for now and only taxes you as if you earned $ 39,000. .
In this particular example using the tax rules for Single Filing Status, your traditional IRA contribution would also move you from the 22% tax bracket to the 12% bracket for single filers. Assuming you don’t qualify for any other tax deductions or credits, this would save you $ 987.50 in taxes for the year. Not bad is not it ?
And you could be even better off if you qualify for the Savers Tax Credit. This is a tax credit available to adults 18 years of age or older who are not students or who are listed as dependents on someone else’s tax return. Tax credits give you a dollar for dollar reduction in your tax bill. So if you qualify for a $ 1,000 tax credit, that is $ 1,000 less than you owe the government.
The Savings Tax Credit amounts to up to 50% of your pension contributions during the year, depending on your adjusted gross income (AGI) and the tax declaration status. Those with a lower AGI benefit from a larger tax credit. In 2020, the maximum credit is $ 1,000 for individuals or $ 2,000 for married couples applying jointly. To get this, you will need to set aside $ 2,000 or more ($ 4,000 or more for married couples) in a traditional IRA or other retirement plan.
But this credit is not accessible to everyone. It aims to encourage low-income households to save more for retirement, so that those who earn too much cannot benefit. In 2020, married couples jointly filing with AGIs over $ 65,000, heads of households with AGIs over $ 48,750, and other filers with AGIs over $ 32,500 will not be eligible for the Savers Tax Credit. But they can still get the tax deduction associated with a traditional IRA contribution.
Locking in money in a retirement account can seem counterintuitive right now when money is tight for many people. But if you choose to make a traditional IRA contribution from the previous year, some of that money will come back to you in the form of a smaller tax bill or a larger tax refund. Plus, the money you put aside for retirement will take years and maybe even decades to grow before you need to use it, in which case it will be worth much more than a few thousand dollars.
It might not make sense to everyone, but an IRA contribution from a previous year is worth considering if you want to save some money this year and be better prepared for retirement.