Yes, even though 2020 is over, you can still make a retirement contribution toward last year’s retirement account contributions limits. However, there are some important details to know if you want to take advantage of these savings benefits.
The tax deadline for 2021 is Monday, May 17th and March 15th for partnerships and corporations, unless you file for an extension on either one of those types of returns. As a financially responsible person, you want to make the most of your tax return. And let’s be honest; that means paying as little as legally possible to the IRS. But did you know one of the best ways to offset your taxes is to invest in yourself by saving into your retirement accounts throughout the year?
While you likely contributed to a retirement account in 2020, there may still be options available to you to contribute more toward your 2020 contribution limits. More contributions can mean more savings come tax day. More importantly, it can help you accelerate your retirement savings goals.
For the purpose of this article, there are two types of retirement accounts to which this applies: IRAs and 401(k)s. Let’s look at traditional IRAs, Roth IRAs, SEP IRAs and Solo 401(k)s.
Traditional IRA
Contributions into a traditional IRA are tax deductible. Therefore, you can make contributions with your earned income. You can also roll other pre-tax accounts into a traditional IRA fairly easily. For example, if you used to contribute to a SEP, but have since incorporated, you can roll your SEP into a traditional IRA.
Roth IRA
You can make a 2020 contribution to a Roth IRA until May 17, 2021. While a Roth IRA is not tax deductible since the money can be withdrawn tax-free during retirement, it is still a good idea to max out your contributions to these accounts if you are able to do so.
SEP (Simplified Employee Pension)
As an employer, you can set up SEPs (simplified employee pensions) for your employees – or for yourself if you are self-employed – and contribute to them throughout the year. These contributions are tax deductible with certain limitations.
Solo 401(k)
Contributions to solo 401(k)s are made with pretax dollars, making them deductible from your taxable income.
Let’s take a closer look at making 2020 contributions to your retirement accounts here in 2021.
What are your contribution and income limits?
The first thing to be aware of is your contribution limits for 2020. The annual contribution limit for a traditional IRA and Roth IRA is up to $6,000 in 2020 or $7,000 if age 50 or older.
The annual contribution limit for a 401(k) is $19,500 or $26,000 for those age 50 or older. It’s important to note that for those over 50, you also have the option of an additional catch-up contribution of $6,500. This helps workers nearing retirement to speed up their retirement savings.
For your SEP, the annual contributions you make to each employee’s SEP cannot exceed the lesser of 25% of compensation, or $57,000 for 2020.
You cannot contribute more to retirement accounts than your “earned income” (wages or business earnings). In other words, if you didn’t work in 2020 and only sold real estate you previously owned, you cannot contribute to a retirement account for 2020.
2020 Income Limits for IRAs
For Married Filing Jointly, you can contribute the maximum of $6,000 (or $7,000 if you are age 50 or older) to a traditional IRA if your Modified Adjusted Gross Income (MAGI) is less than $196,000.
- If your MAGI is between $196,000 and $205,999, your ability to contribute is reduced.
- If your MAGI is $206,000 or more, you may not contribute pre-tax dollars.
For Single, Head of Household, or Married Filing Separately, you can contribute the maximum of $6,000 (or $7,000 if you are age 50 or older) to a traditional IRA if your Modified Adjusted Gross Income (MAGI) is less than$124,000.
- If your MAGI is between $124,000 and $138,999, your ability to contribute is reduced.
- If your MAGI is $139,000 or more, you may not contribute pre-tax dollars.
For Married Filing Separately (if you lived with your spouse at any time during 2020), if your Modified Adjusted Gross Income (MAGI) is less than $10,000, your ability to contribute is reduced.
- If your MAGI is $10,000 or more, you may not contribute pre-tax dollars.
It’s 2021; why should I still make a 2020 contribution?
Even though calendar year 2020 is over, you can still make contributions to your retirement accounts for 2020 if your income doesn’t exceed the maximums to make deductible contributions and you haven’t reached your contribution limits.
Many people make lump sum contributions into their pre tax retirement accounts before the tax filing deadline simply as a way to maximize the benefit of doing so.
It can also help offset any owed taxes. After all, even with the best tax planning, life happens. Maybe you sold real estate or earned more income than you originally anticipated. There are a myriad of reasons that your taxes can end up being higher than you planned. If you haven’t maxed out your contributions in 2020, a 2020 contribution now can give you the opportunity to pay yourself first before Uncle Sam.
Whenever you discover that you’re going to owe the IRS and you want to reduce your tax bill, considering a contribution to your retirement is always smart. As long as you didn’t max out your Roth or Traditional IRA contributions in 2020 already, you can still contribute to those accounts up to the limit.
This will provide a welcome tax break while also building up your retirement accounts.
Are you self-employed or a business owner? You’ll love this.
If you’re a business owner or self-employed, you could get an even bigger tax break when it comes to investing into your retirement accounts. While you may be familiar with a traditional 401(k), business owners can take advantage of the benefits that come with a Solo 401(k), also called an Individual 401(k).
A Solo 401(k) is just like a traditional 401(k), except it’s specifically for business owners who have no W-2 employees other than themselves (and their spouse). Contractors or vendors whose compensation is documented at the beginning of the year with a Form 1099 do not count as employees when it comes to qualifying for a Solo 401(k). These accounts allow you to make both employee and employer contributions for yourself (since you are both the employee and the employer), which means you can make significantly higher contributions to your retirement accounts than most people!
What does this mean? Well, instead of maxing out at $19,500 with a traditional 401(k), the Solo 401(k) limit for combined employee and employer contributions is $57,000 for the 2020 tax year ($63,500 if you are age 50 or older). While we’ve listed the maximum contribution amounts for 2020, the actual amount of the employer contributions should be calculated by your tax preparer and is based on your business profits for 2020.
If you’re self employed or a business owner, you would significantly reduce your tax bill while bolstering your retirement savings. It’s a win-win. Just remember, the tax filing deadline for most businesses other than sole proprietors is March 15th. Of course, many business owners file an extension, which also extends your contribution deadline to the new extension deadline.
Ready to win this tax season?
Nobody wants to overpay in taxes. If you haven’t maxed out your retirement contributions for 2020 and have the opportunity to reduce your tax bill, then consider putting a little more into your retirement savings.
We get it – planning for retirement (and managing your taxes) can be confusing. Working with a fee-only fiduciary financial advisor can help. We coordinate with our clients’ CPAs to ensure our clients do everything they can to grow and sustain their wealth – and that includes being vigilant about tax-related money matters.
Interested in learning more about our fee-only fiduciary financial advisor services? We’re starting to accept new clients this March, and we’d love to talk. Click here to get started.
Also of note: On February 22, 2021, the IRS announced that victims of the 2021 winter storms in Texas will have until June 15, 2021, to file individual and business tax returns and make payments. This would mean that those individuals also have until June 15, 2021 to make 2020 IRA contributions.
