The April tax deadline is approaching. However, it’s not too late to dig up some extra savings on your taxes. Contributing to a traditional or Roth IRA for the 2020 tax year is an easy way to score an additional deduction or a credit, both of which can cut your tax bill or pump up your refund, while also increasing your retirement savings. If you’re thinking of opening IRA ahead of the filing deadline, here are a few things to keep in mind.
Find out now: How much do I need to save for retirement?
1. Traditional IRA Contributions Are Deductible
A traditional IRA is funded using pre-tax dollars. That means that once you start taking distributions, you’ll have to pay taxes on the money at your regular rate. The upside is that you can deduct the money you put in, which can reduce your taxable income for the year. Note that you can deduct your IRA contribution even if you’re not itemizing deductions.
With a Roth IRA, contributions are made on an after-tax basis. That means you won’t be able to write off anything you save. The trade-off is that when it’s time to take the money out, you won’t owe any additional tax. Why? Because you’ve already paid the tax on the money you put in.
When you’re trying to decide which kind of IRA to open, consider both the short-term and long-term tax benefits. If you’re expecting to be in a lower tax bracket once you retire, taking the deduction now for a traditional IRA may yield the bigger tax benefit. If you think your tax rate will go up as you get older, paying the taxes on your Roth contributions now can save you money later on.
2. Your Tax Benefits May Be Limited
The IRS has specific guidelines about who can open an IRA, including limits on Roth contributions and traditional IRA deductions. With a Roth IRA, your ability to save the full $6,000 allowed for the 2020 tax year is determined by your income and filing status. If you’re single, you can contribute the max as long as your adjusted gross income is less than $124,000. If you’re married and filing jointly, the limit goes up to $196,000.
With a traditional IRA, single filers can write off the full amount regardless of what they earn as long as they’re not covered by an employer’s retirement plan. If they are in 2020, the deduction begins to phase out once their income passes $65,000. Married and covered by a plan at work? In 2020, you can only claim the full deduction if your joint income isn’t more than $104,000. If you’re not covered but your spouse is, the limit increases up to between $196,000 and $206,000 in 2020.
3. Lower-Income Workers Get Extra Credit
The Retirement Saver’s Credit is another tax incentive that’s geared specifically towards people who don’t earn huge amounts of cash. The credit is good for 10%, 20% or 50% of your total IRA contribution up to $2,000 (or $4,000 if you’re married and filing jointly). The amount of the credit you qualify for is based on your adjusted gross income.
For the 2019 tax year, single filers get the 50% credit if their adjusted gross income (AGI) isn’t higher than $19,250. Once your income passes $32,000, you’re no longer eligible for the credit. Married couples can qualify for the 50% credit with a combined income of $38,500 or less. At the $63,000 mark, the credit is phased out entirely. For 2020, you’ll need an AGI of $19,500 to get the 50% credit. Married couples will need a combined income of $39,000 or less. You’ll be eligible for the 2020 credit as long as your income doesn’t pass $32,500.
4. Make Sure You’re Choosing the Right Tax Year
When you open an IRA before the tax deadline, you can elect to make contributions for the previous or current year. To get the tax breaks for 2020 year, make sure you’re maxing out your contributions for 2019 first before saving anything for the 2020 tax year. If you’re contributing to an IRA in early 2020, the brokerage where you have your IRA account should allow you to indicate whether the contribution is for the 2019 or 2020 tax year.
For 2019, the maximum IRA contribution was $6,000. People age 50 and older could make an extra $1,000 catch-up contribution. That maximum contribution is the same for 2020. That means the limit is $6,000 per person, plus an extra $1,000 (to bring the total limit to $7,000) if you’re age 50 or older.
- Figure out which type of IRA is right for you. With a traditional IRA, contributions are made with pre-tax dollars, which might be good if you expect to be in a lower tax bracket after retirement. A Roth IRA, on the other hand, is funded through after-tax contributions, making it a good option if you think your tax rate will go up as you get older.
- Opening an IRA is a good step in the right direction, but you might also benefit from talking to a financial advisor to come up with a complete plan for funding your retirement. A matching tool like SmartAsset’s can help you find a financial advisor to work with to meet your needs. First you’ll answer a series of questions about your financial situation and goals. You’ll then be matched with up to three financial advisors in your area, at which point you can read their profiles to learn more about them, interview them on the phone or in person and choose who to work with.
Photo credit: flickr/wanderingforward, ©iStock.com/PeopleImages, ©iStock.com/AndreyPopov