Contributing to a 401(k) plan can save you thousands of dollars on your 2020 tax return, but you need to meet the year-end contribution deadline. You can also take emergency retirement account withdrawals to cope with coronavirus costs until the end of the year without having to pay the early withdrawal penalty.
Remember these year-end retirement account deadlines:
— Contribute to your 401(k) plan by Dec. 31.
— Retirees can skip required minimum distributions for 2020.
— Take coronavirus expense withdrawals by the end of the year.
— Donate your IRA distribution to charity.
— Qualify for the saver’s credit.
— More time for IRA contributions.
Here’s how to maximize the value of your retirement accounts before the end of the year.
Meet the 401(k) Contribution Deadline
Deposits to your 401(k) plan are typically due by the end of the calendar year. However, many people contribute to 401(k) plans via payroll withholding, and it might take your company a pay period or two to process the change.
“It really is a good idea for savers to aim to initiate their transactions a little earlier than the deadline,” says Ted Mitchell, Fidelity’s director of public relations for retirement strategies. “At the very least, aim for two to three weeks earlier.”
Boosting your 401(k) contributions could significantly decrease your 2020 tax bill. A 50-year-old worker in the 24% tax bracket who maxes out his 401(k) would reduce his tax bill by $6,240. Even a $1,000 contribution would save him $240 in taxes.
“Each dollar contributed reduces your overall tax bill, so that can have an immediate impact,” says Steven Sivak, a certified financial planner and managing partner for Innovate Wealth in Pittsburgh.
Skip Required Minimum Distributions
Distributions from 401(k) plans and traditional IRAs usually must be taken by Dec. 31 each year after age 72. The penalty for missing a required minimum distribution is 50% of the amount that should have been withdrawn in addition to regular income tax on the distribution. However, those who don’t need the funds can skip their 2020 required minimum distribution due to provisions of the CARES Act.
“If a retiree does not need the money, I’d recommend not taking it in 2020,” says Luis Rosa, a certified financial planner and founder of Build A Better Financial Future in Henderson, Nevada. “This can save money in taxes since the required minimum distribution is taxable income.”
Take Distributions for Coronavirus Costs
Retirement savers can withdraw up to $100,000 from a 401(k) or IRA to pay for coronavirus expenses until Dec. 31, 2020, without having to pay the usual 10% early withdrawal penalty. These emergency retirement account withdrawals are permitted for those who are diagnosed with COVID-19, have a spouse or dependent who tests positive or who have experienced financial problems as a result of being quarantined, laid off, working fewer hours or a lack of child care due to the pandemic.
Income tax will be due on hardship withdrawals from tax-deferred accounts and can be paid over a three-year period.
“If this distribution will prevent them from losing their home or will allow them to feed their family, it makes sense to take the distribution. Do not take a distribution for discretionary expenses or nonessential purchases,” says Denise Downey, a certified financial planner for Financial Trex in Spokane, Washington. “Taking this money now may result in a delayed or altered retirement.”
Those who experience an improvement in their financial situation can put the funds back in a retirement account during the three years after the distribution.
Donate Your IRA Distribution to Charity
IRA owners who are age 70 1/2 or older can avoid paying income tax on part or all of their required distribution if they directly transfer an IRA withdrawal to a qualifying charity. An IRA charitable contribution of up to $100,000 can also be used to satisfy the minimum distribution requirement.
“If you are a retiree over 70 1/2 not needing your distributions, you can avoid paying income tax on your required minimum distributions by donating up to $100,000 of your distribution to charity,” says Ajay Kaisth, a certified financial planner for KAI Advisors in Princeton Junction, New Jersey. “To qualify for the tax break, charitable distributions must be paid directly from your IRA to a qualified charity by the end of the calendar year.”
Qualify for the Saver’s Credit
If your adjusted gross income is less than $32,500 as an individual, $48,750 as a head of household or $65,000 as part of a married couple in 2020 and you contribute to a retirement account, you might be able to qualify for the saver’s credit. This tax credit is worth 10%, 20% or 50% of retirement account contributions of up to $2,000 for individuals and $4,000 for couples, with the exact amount of the credit depending on your income.
“You can get the deduction, and then lower- and middle-income people can get a saver’s credit on top of that,” Kaisth says. “This is different from a tax deduction. A tax credit is a dollar-for-dollar reduction of gross tax liability.”
More Time for IRA Contributions
While 401(k) contributions are generally due by the end of the calendar year, you have until April 15, 2021, to make an IRA contribution that will qualify you for a tax deduction on your 2020 return. You can contribute to an IRA shortly before filing your taxes to get a nearly immediate reduction in your tax bill.
“Deadlines for contributions are the tax filing deadline in mid-April, but if you wait until early 2021 to make the contribution, make sure you specify the contribution is for 2020,” says Laurie Dubchansky, a certified financial planner for Havaplan Financial in Newport Beach, California. “Doing so will give you an opportunity to make another deposit for 2021.”
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Update 10/19/20: This story was published at an earlier date and has been updated with new information.