February, 2022
With April 15 around the corner, it’s time to start thinking about funding your retirement account, if you haven’t done so already. Here are some things you need to know.
Retirement 101
The SECURE Act allows owners of traditional IRAs to keep contributing to their accounts past age 70 1/2. Since the money you put into a traditional IRA is tax deductible, you could lower your income tax. Note: You will have to pay taxes on that money when you take it out.
Traditional IRAs and Roth Conversion
You have until April 15, 2022 to fund both traditional and Roth IRAs.
For 2021, the maximum IRA contribution you can make is $6,000 (if age 50 or older, you are allowed a catchup contribution of an additional $1,000).
Qualified charitable distributions (QCDs) reduce your taxable income
If you are forced to take money from your IRA account to meet your required minimum distribution (RMD) and you want to lower your tax burden, you might consider making a qualified charitable distribution directly from your IRA account.
Roth Conversions:
Converting some of your retirement savings from a traditional IRA to a Roth IRA could make sense if you expect your taxes to increase in the future. Roth accounts use post-tax money and don't have required minimum distributions (RMDs). They can be a good way to save on taxes during retirement because you’ve already been taxed on that money.
Some benefits from Roth IRA Conversions include:
- May lower your overall taxable income long-term.
- Tax-free compounding.
- No RMDs (at age 72).
- Tax-free withdrawals for beneficiaries.
Although choosing to contribute to a Roth IRA instead of a traditional IRA will not cut your 2021 tax bill—Roth contributions are not deductible—it could be the better choice because all withdrawals from a Roth can be tax-free in retirement. Withdrawals from a traditional IRA are fully taxable in retirement.
You should always discuss your individual situation with your tax professional.
If you don’t have a company-sponsored retirement plan you can make a deductible contribution regardless of your income; however, if you are covered by a retirement plan at work, the IRS phases out your deductibility based on income.
IRA deduction is phased out for active participants in an employer plan for modified adjusted gross income between $66,000-$76,000 for single filers, $105,000- $125,000 for joint filers and $1,000-$10,000 for those married filing separately.
If your spouse is an active participant in an employer plan but you are not, then the limits go up to $198,000- $208,000.
The Roth contribution limit is phased out for modified adjusted gross incomes between $125,000-$140,000 for Single Filers, $198,000-$208,000 for joint filers and $0-$10,000 for those married filing separately.
For self-employed persons, the maximum annual addition to SEPs and Keoghs for 2021 is $58,000.
The IRS allows you to transfer up to $100,000 to a qualified charity.
Since QCDs are not included in income, the QCD is also not deductible. As such, the QCD can remain an option for your charitable giving, even if you claim the standard deduction in a given year. If you claim the standard deduction, you won't be allowed to itemize things like charitable donations.
The rules of QCD
As with any tax strategy, it's important to pay close attention to the IRS rules.
- The retirement account owner must be age 70 1/2 or older.
- The annual QCD limit is $100,000 per account owner. Note: the limit can exceed the annual required minimum distribution.
- Donations must go directly from your IRA to the qualified public charity.
- Most types of IRAs qualify: traditional IRA, rollover IRA, inherited IRA, and inactive SEP and SIMPLE IRAs.
- QCDs only apply to taxable distributions.
- Making tax-deductible IRA contributions can reduce your deduction for qualified charitable distributions when both are made in the same tax year.
With a qualified charitable distribution, a check is sent directly from an IRA to a qualified charity. This allows the donor to exclude the amount from taxable income. Generally speaking, RMDs will increase taxes:
- RMDs can put you into a higher tax bracket. Since distributions are taxed as ordinary income.
- Medicare surtax. RMDs increase your modified adjusted gross income, or MAGI, which could trigger the 3.8% Medicare surtax. The surtax applies to the lesser of net investment income or MAGI in excess of $200,000 for individuals or $250,000 for married couples filing jointly.
- Taxing Social Security. Even small withdrawals from a retirement account can cause Social Security benefits to become taxable, up to 85% for single filers with income above $34,000 annually or married couples with income above $44,000.
- Medicare Part B and D premiums are calculated using a taxpayer's MAGI from the prior year. So large RMDs can cause sharp increases to your Medicare costs.