The shift from the 2020 calendar to 2021 is nothing more than turning the proverbial page, but your accountant may disagree. 2021 marks the beginning of a new accounting period, which, in itself, can bring a wave of confusion to the average taxpayer. Given that we still have a few months until tax returns are due, it is advisable to think now about how you can reduce your 2020 tax obligation – even though 2020 is already over. Next, we’ll explore a popular way to reduce your taxes owed – contributing to a traditional IRA.
Contribute retroactively to 2020
The calendar year has obviously ended, but the IRS offers a three and a half month “regroupment” period before your tax return actually needs to be completed (that is, from January 1 to April 15). During that time, you must be thinking about your spending in 2020: Have you made any charitable contributions? Did you have any medical expenses that were not covered by insurance? These questions, among others, are central to the “retrospective” process that takes place before April 15.
A simple and widely applicable way to reduce your tax liability for 2020 is to contribute to a traditional IRA. Assuming you meet the income limits and eligibility criteria to do so, a maximum contribution of $ 6,000 ($ 7,000 for people over 50) will reduce your gross income by the same amount. If you have money available to make such a contribution, or if you have low risk money in a taxable brokerage account, you can consider transferring money to a traditional IRA to receive an immediate tax benefit for 2020.
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Read the fine print
This strategy works for people in very specific circumstances. In the simplest example, suppose you are a single contributor. If you are covered by a workplace retirement plan, such as 401 (k) or 403 (b), you are eligible to contribute a traditional IRA if your AGI (adjusted gross income) is less than $ 61,000; if you are not covered by a professional retirement plan, your contribution is fully tax-deductible.
In addition, the $ 6,000 limit on IRA contributions applies to the sum of contributions to traditional and Roth IRAs, which means that if you have already contributed the maximum to a Roth IRA, the traditional IRA contribution and the corresponding deduction will not be available to you. Simply put, you need to look at your traditional and Roth contributions as a single number when comparing it to the annual limit.
Right for some, but not for others
The deduction will work for some, but not all taxpayers, and will generally benefit single taxpayers who earn less than $ 61,000 and married taxpayers who collectively earn less than $ 98,000. This deduction will also work for those who are not covered by a professional retirement plan. In addition, for a traditional IRA to be preferable to a Roth IRA, you also need to expect your tax rate to be higher now than in retirement.
If you find yourself out of that scenario, it definitely makes sense to look for a Roth IRA contribution – or, if you are above the income limits to contribute directly to a Roth, a Backdoor Roth IRA contribution. Although you will not receive any immediate tax benefits to add to a Roth IRA, you will reap significant long-term benefits as the account will never be taxed again.
Do this by April 15th
If you fall into a category eligible for IRA contribution and deduction, be sure to really make the contribution until April 15 to reduce your tax obligation from last year. Many of the popular tax programs will ask you to do this if you enter a tax scenario that requires such a contribution.
Even if you are outside the inclusion parameters, there is still time to improve your overall tax profile, including contributing to a Roth IRA or considering a Backdoor Roth IRA. Regardless of which path you take, there is still time to affect the 2020 accounting period.