Use tax-deferred retirement accounts to shelter income from current taxes.
Contributing to a tax-deferred retirement plan at work is a great way to minimize your current taxes. The money you contribute reduces the amount of income your will be taxed on this year – and it helps pave the way to a financially secure retirement. For example, if you contribute $15,000 this year, you do not have to pay income tax on that $15,000 of income this year, and you are $15,000 closer to your retirement savings goal!
Contributing to a traditional IRA can also help minimize your current taxes as long as you are eligible to deduct your contributions. Your contributions will be tax deductible if you and your spouse (if you’re married) are not covered by retirement plans at work. If either of you is covered, your income must be under certain limits for your contributions to be tax deductible.
Keep in mind that contributing to a tax-deferred retirement account minimizes your current taxes. You will eventually have to pay income tax on your pre-tax or deductible contributions, as well as your investment earnings, but not until they are withdrawn from the retirement account, which may be decades from now.
In certain situations. You may prefer to skip the current tax benefit and contribute instead to a Roth IRA or Roth retirement account so that your withdrawals will be tax-free in retirement.
NEW: The age limit on contributing to a traditional IRA is removed.
Prior to 2020, individuals were not allowed to contribute to traditional IRAs if they were age 70 ½ or older. The SECURE Act of 2019 removed the age limit, and you can now contribute at any age as long as you (or your spouse if filing jointly) earn taxable compensation, such as wages.
Business Owners: Start your own retirement plan!
If you are self-employed or own a business and want to contribute more to your retirement savings each year than IRAs allow, consider starting a business retirement plan.
Business retirement plans typically allow you to contribute far more each year on a tax-deferred basis than a traditional IRA does. For example, one type of business retirement plan, the SEP IRA, allows you to contribute from 0% to 25% of your compensation every year, up to a maximum of $57,000 in 2020. In contrast, traditional and Roth IRA contributions are limited to $6,000 at most this year, or $7,000 if you are age 50 or older.
Use a health savings account to shelter your income from taxes.
Contributing to a health savings account (HSA) is a great way to shelter some income from taxes if you have a high-deductible health plan (HDHP). Money that you contribute to an HSA is either pre-tax or tax deductible, which lowers your taxable income and taxes for the current year. Plus, earnings grow tax-free and withdrawals for qualified medical expenses are tax-free.
For 2020, you may be able to contribute as much as $3,550 if you have self-only HDHP coverage or $7,100 if you have family HDHP coverage. $1,000 catch-up contributions can be made for those age 55 or older.
We can assist you with these and other tax savings strategies so please reach out to us in Williston (802.878.1963) or Rutland (802.775.7132) for personalized advice.
If you are interested in establishing a business retirement plan, please contact us ASAP. Some plans must be established by the end of your business’s fiscal year (generally December 31) and others by the due date of your tax return, including extensions.
This article is published in the November 2020 edition of Eye on Money. If you would like to be added to Copper Leaf Financial’s mail list for this publication please email [email protected].
*Copper Leaf Financial is an affiliated and separately registered entity.