How to Avoid Deduction Errors from Individual Retirement Accounts

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At the end of the year, those looking to lower their tax bill may want to consider an individual retirement account contribution. Before transferring the funds, however, there are rules and limits that investors should be aware of, according to financial experts.

“Anyone can contribute to a traditional IRA – you, me, Jeff Bezos,” said certified financial planner Howard Pressman, partner at Egan, Berger & Weiner in Vienna, Virginia.

However, the ability to cancel IRA contributions depends on two factors: participation in workplace pension plans and income.

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For 2021, a person can deposit up to $ 6,000 into their IRA ($ 7,000 for someone 50 or older), provided they have earned that much income, at any time before the filing deadline. income.

An investor and his or her spouse can be “in the clear” to write off all of their IRA contributions if both spouses do not participate in an employer’s pension plan, said Larry Harris, CFP and director of tax services at Parsec Financial in Asheville, North Carolina. .

However, the rules change if either partner has coverage and participates in the plan, including employee or company deposits.

For example, participation may include employee contributions, company counterparties, profit sharing, or other employer deposits.

IRA deduction limits and phase-outs

Single investors using a workplace retirement plan can claim tax relief for their entire IRA contribution if their modified adjusted gross income is $ 66,000 or less.

While there is still a partial deduction before they reach $ 76,000, the benefit wears off once they reach that threshold.

Married couples who file together can receive the full benefit with $ 105,000 or less, and their partial tax relief is still available before reaching $ 125,000.

There is an IRS table covering each of these limits here.

Spouses who don’t work outside the home can also contribute based on the income of the earning spouse, in what’s called a spousal IRA, Pressman added.

“This also has income limits, but they are higher than those of workers covered by a plan,” he said.

Options if you cannot deduct

While some investors may not qualify for IRA contribution deductions, there are other options to consider.

Non-deductible IRA contributions are a popular choice because some investors may qualify to convert the after-tax deposit to a Roth IRA, known as a “backdoor” maneuver, bypassing income limits.

However, the tactic can be on the chopping block.

House Democrats want to crack down on strategy, regardless of income level, after Dec.31, according to a summary released by the House Ways and Means Committee.

But with the budget on the move, it’s unclear whether the provision will go through negotiations.

Other options may include the maximum of a workplace pension plan, including catch-up contributions for those who are 50 and older, suggests Pressman.

After that, someone may consider investing in low turnover index mutual funds in a regular brokerage account.

“This account will not be subject to retirement rules, limiting your access to funds, and when you receive distributions, your growth will be taxed at more favorable capital gains tax rates rather than ordinary income rates. higher IRAs, ”he added.

“While you will have to pay taxes on capital gains and dividends every year, using low turnover index funds should keep those taxes to a minimum,” he said.

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