A month left for 2020 retirement contributions
With the federal tax filing deadline less than a month away, it’s well worth taking a final reflection on your retirement account contributions for the 2020 tax year.
Because of the coronavirus pandemic, the IRS extended the filing deadline to May 17. If your contribution is postmarked by that date, your contribution will be accepted.
Regulations governing retirement contributions are complex, which leads to a lot of confusion. Ed Slott & Co. (www. irahelp.com) recently identified many of the common misconceptions, and I’ll discuss a few below.
Age limits on traditional IRAs. Thanks to the SECURE Act of 2019, if you have earned income, you have more flexibility contributing to your retirement account. Prior to the SECURE Act, those older than 70 could only make contributions to Roth accounts. The new regulations allow you to make contributions to traditional IRAs as well as Roth accounts, regardless of your age. This flexibility does not affect your responsibility to take required minimum distributions if you reached 70 before December 31, 2019 and have assets in your retirement accounts at the end of 2020.
Contributing even if you don’t have earned income. There is one exception to the earned-income requirement. If you file a joint return, a contribution can be made to each two IRA accounts in 2020.
Example: John and Mary file a joint return, with modified adjusted gross income (MAGI) of $60,000. John did not work in 2020. Mary earned $50,000. A $6,000 IRA contribution can be made to each IRA account for 2020.
Contributions from other sources. As long as you have sufficient earned income, you can make contributions even if your funds are supplied by parents, grandparents or other parties. Current estate tax laws allow individuals to make gifts of up to $15,000 per person without affecting lifetime estate tax exemptions. Current regulations provide generous credits, known as savings credits, to individuals with relatively low income. For single filers, the upper income limit is $33,000; for married joint returns, the limit is $66,000. The regulations allow a credit of 50% of contributions up to $2,000. Accordingly, if you qualify and you contribute $2,000 to your retirement account in 2020, you will save $1,000.
Example: Joan, who files as a single person, earned $30,000 in 2020. Her father contributed $6,000 to her IRA. $6,000 is the upper limit for contributions in 2020. By contributing $6,000 to her traditional IRA, she receives a $1,000 savings credit. Her contribution is not taxable, because contributions to traditional IRAs are not taxable. The credit reduces her federal tax liability by $1,000. If total gifts made by her father in 2020 do not exceed $15,000, his lifetime allowance for estate tax purposes is not affected.
Using the “backdoor” option when your income is too high. Even if your income is too high to make a Roth IRA contribution, you are allowed to use what is called the “backdoor” option. If your income is greater than $124,000, you can still make a traditional IRA contribution and then convert that contribution to a Roth IRA, regardless of your age.
Options you have even if you participate in an employer-retirement plan. Many people erroneously believe that if
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they make the maximum contribution to their workplace retirement plan, they will be unable to make independent contributions to their IRA account.
As long as income is within established limits, additional contributions can also be made to IRA accounts. However, the ability to deduct a traditional IRA contribution phases out at higher income levels for active plan participants. For example, contributions to traditional IRAs are allowed a full deduction only if MAGI is $104,000 or less for workers filing joint returns, and $65,000 or less for single filers. However, Roth contributions can be made for married filers with MAGI of $196,00 or less, and for single filers with MAGI of $124,000 or less.
Example: John, who is single and age 45, had reported MAGI of $100,000 income in 2020. He is allowed to contribute $19,500 to his 401(k) account with his employer’s account. He also is able to contribute $6,000 to a Roth IRA account because his MAGI is less than $124,000. (Individuals older than 50 could contribute an additional $6,500 to their 401(k) account and an additional $1,000 to their IRA account.)