Contributing to a 401(k) plan can save you thousands of dollars on your 2021 tax return, but you need to meet the year-end contribution deadline. Retirees must take withdrawals from their 401(k)s and traditional IRAs before the end of the year to avoid a stiff tax penalty. Here’s how to maximize the value of your retirement accounts before the end of the year.
Remember these year-end retirement account deadlines:
— Contribute to your 401(k) plan by Dec. 31.
— Take required minimum distributions.
— Donate your IRA distribution to charity.
— Qualify for the saver’s credit.
— Take 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 2021 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.
Take Required Minimum Distributions
Distributions from 401(k) plans and traditional IRAs 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 The penalty for missing a required minimum distribution is 50% of the amount that should have been withdrawn in addition to regular income tax on the distribution.
You get extra time to take your first required minimum distribution. If you turned age 72 in 2021, you have until April 1, 2022, to take your initial required minimum distribution. However, your second and all subsequent distributions will be due by Dec. 31 each year. Waiting until April to take your first distribution means you will need to take two distributions in the same year, which could result in an abnormally high tax bill.
Roth 401(k)s have an annual distribution requirement, but Roth IRAs do not. “A strategy for individuals with a Roth 401(k) account is to roll over all Roth 401(k) funds to a Roth IRA prior to Dec. 31, before they turn 72,” says Ajay Kaisth, a certified financial planner for KAI Advisors in Princeton Junction, New Jersey. “A Roth 401(k) plan that has a zero balance as of Dec. 31 will not be impacted by required minimum distribution requirements on the Roth 401(k) assets.”
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,” Kaisth says. “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 $33,000 as an individual, $49,500 as a head of household or $66,000 as part of a married couple in 2021 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.”
Take More Time for IRA Contributions
While 401(k) contributions are generally due by the end of the calendar year, you have until your tax filing deadline in April 2022 to make an IRA contribution that will qualify you for a tax deduction on your 2021 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 2022 to make the contribution, make sure you specify the contribution is for 2021,” 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 2022.”
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Update 10/25/21: This story was published at an earlier date and has been updated with new information.