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Deck the Halls .... After You Fund Your IRA!

The turkey’s gone, the tree is up, and soon we’ll be ringing in the new year! The final few weeks of the year always seem to go by in a rush, so now is the time to make sure you have your 2018 tax planning in shape. Our recent blog offered several year-end tax strategies. However, one area we didn’t discuss then is a topic that many taxpayers neglect even though it can have a large impact on their taxes. Let’s take a look at retirement plans and how properly using them can help maximize your tax return’s bottom line.

Retirement plans include a wide array of account types. Anyone with earned income may contribute to a Traditional Individual Retirement Arrangement (IRA). For 2018, the contribution limit is $5500 ($6500 if you are age 50 or older); this increases by $500 in 2019. Income, filing status, and whether or not you and your spouse are covered by a retirement plan at work will determine if any (or all) of the contribution may be deducted on your return. Deductible IRA contributions reduce a taxpayer’s Adjusted Gross Income (AGI), thus decreasing the amount of tax owed for the year. Of course, when the time comes to withdraw funds from the IRA, the money withdrawn will be taxed at the IRA owner’s then-current tax rate.

Taxpayers wishing to avoid taxable withdrawals may want to investigate ROTH IRAs. These accounts are funded with post-tax money, so no deduction is allowed when you contribute. However, if the rules are followed, the funds may be withdrawn tax-free. There are income limits regarding who may contribute to a ROTH; if you qualify, the same $5500/$6500 limits that apply to Traditional IRAs are in effect. Also keep in mind that the IRA limits are for all IRAs combined that the taxpayer may own and that penalties are in place for those who contribute too much to their IRAs.

Depending upon whether you work in the public or private sector, you may have access to a 401(k) or 403(b). Employees may contribute up to $18,500 in 2018; the limit rises to $19,000 in 2019. Taxpayers who are age 50 or older may contribute an extra $6000. These contributions are pre-tax, thereby reducing the taxpayer’s AGI and ultimately the tax owed. As with other pre-tax plans, withdrawals will be taxable to the owner when funds are distributed.

All of these accounts are intended to be long-term savings vehicles for retirement. Failing to follow the many rules regarding contributions, holding periods, and withdrawals can result in penalties and unwelcomed tax bills. We frequently see taxpayers who withdraw funds from one of these accounts without understanding that they will owe penalties and tax. While there are a few exceptions, most who withdraw funds from pre-tax accounts prior to age 59 ½ will incur a 10% penalty on top of the income tax owed. Therefore, we advise anyone wishing to invest in a retirement account to seek advice from a qualified financial advisor and their tax professional to make sure they choose the best plan for their circumstances and use it most effectively.

So how does this relate to end-of-year tax planning? Keep in mind that the limits discussed above are just that – caps on the amount that may be contributed. Pre-tax contributions can be used to manipulate AGI to lower taxes, qualify for certain credits, or set up other tax-related strategies, often with contributions that are far less than the maximum allowed.

It’s possible that saving a modest amount for your future can let you save on your taxes without taking too large a bite out of you paycheck. And with the Saver’s Credit, taxpayers whose AGI is under the limits ($31,500 for Single filers, $63,000 for Married Filing Jointly) may actually get a tax credit for saving! The computations can get complex, so let us help you with that. We’ll do the hard math stuff so you can enjoy all of the festivities of the holiday season, knowing you are preparing for your future while saving on your current taxes.

hand putting money in retirement bank


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