personal finance | may 3, 2021
Save Money Today: How to Lower Your 2020 Taxes
You have until May 17, 2021, to make contributions that could help lower your taxable income for 2020.
These “above the line” deductions are allowed whether you use the standard deduction or itemize your deductions.
Contributions to IRAs, spousal IRAs, SEP-IRAs, and HSAs may be fully or partially deductible for tax year 2020.
Certain households may also benefit from a saver’s tax credit.
Judith Ward, CFP®
Senior Financial Planner
Most tax-related activity had to be completed by year’s end to affect taxable income for 2020. However, there are a few ways individuals can still reduce their taxable income for last year. And these tax deductions are allowed whether you use standard or itemized deductions. Commonly called “above the line” deductions, these are captured on your IRS Form 1040 Schedule 1 as Adjustments to Income, and they must be made by the tax filing deadline which has been extended to May 17, 2021.
There’s still time to make a $6,0001 ($7,000 if age 50 or older) contribution to your individual retirement account (IRA) for the 2020 tax year. You may be able to deduct some or all of the amount of the contribution depending on your income level and if you (or your spouse) are covered by a retirement plan at work.
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Tax Year 2020 Income Limits for Traditional IRA Deductibility
|Filing Status*||Covered by Retirement Plan at Work||Deductibility Based on Adjusted Gross Income (AGI)|
|Single/Head of Household||No||Full
||Full: $65,000 or less|
|Phased out: >$65,000–<$75,000|
|Married Filing Jointly||Neither you nor your spouse||Full|
|You are not, but spouse is||Full: $196,000 or less
|Phased out: >$196,000–<$206,000|
|You are||Full: $104,000 or less|
|Phased out: >$104,000–<$124,000|
*Consult IRS rules or a tax professional if your status is married filing separately or qualifying widow(er).
Spousal IRA Contribution
Generally, you must have earned income to contribute to an IRA. However, if your spouse doesn’t earn income or has very little compensation, they can fund their own IRA up to the contribution limit based on your compensation if you file a joint income tax return. While your combined IRA contributions can’t exceed your combined income, you could possibly double up the amount of your deduction depending on the limits outlined in the previous table (See Tax Year 2020 Income Limits for Traditional IRA Deductibility).
Small business owners and self-employed individuals may use a simplified employee pension (SEP) plan to save for retirement. Each eligible employee, including the business owner, has an individual SEP-IRA under the plan that is funded solely by the employer. The contribution limits are quite generous at 25% of compensation (up to $57,000) for tax year 2020. The contribution amount is tax-deductible for the employer. Contributions may be made by the due date (including extensions) of the business’s income tax return for that year.
If you participated in a high deductible health plan (HDHP), you can contribute $3,550 for individual or $7,100 for family coverage for tax year 2020 to a health savings account (HSA). Many people use HSAs to cover immediate, out-of-pocket health care costs. But they are also a good way to invest for the long term—tax-free—to offset future health expenses in retirement. Your contribution amount is generally fully tax-deductible and is recorded on IRS Form 8889 (Health Savings Accounts (HSAs)).
Certain households making contributions to an IRA or workplace retirement plan may also benefit from a tax credit called a Saver’s Credit. If your income is less than certain thresholds, you could receive a tax credit up to $1,000 ($2,000 if married filing jointly). While $1,000 to $2,000 may not seem like a large sum, a tax credit reduces your tax liability dollar for dollar. This credit, however, will not result in a tax refund if your tax liability is less than zero. If you fall into the categories listed in the next table, you may want to spend a little extra time to complete IRS Form 8880 (Credit for Qualified Retirement Savings Contributions).
If you haven’t taken full advantage of your 2020 tax deductions, now’s the time to act. Determine what type of contributions you’re eligible for, along with what works best for your overall financial plan. Saving as much as you can now may provide a tax break today, but it could also grant you valuable time to allow your investments to grow for the future.
Tax Year 2020 Saver’s Credit
||Tax Credit Rate
|Single**||$32,500 or less
||Up to 50% contribution amount
(Maximum qualifying contribution = $2,000)
|Head of Household||$48,750 or less|
|Married Filing Jointly||$65,000 or less||Up to 50% contribution amount
(Maximum qualifying contribution
**Includes married filing separately or qualifying widow(er).
1For 2020, the total contributions you make each year to all of your traditional IRAs and Roth IRAs can’t be more than $6,000 ($7,000 if you’re age 50 or older), or if less, your taxable compensation for the year.
This material is provided for general and educational purposes only and not intended to provide legal, tax, or investment advice. This material does not provide recommendations concerning investments, investment strategies, or account types; it is not individualized to the needs of any specific investor and not intended to suggest any particular investment action is appropriate for you, nor is it intended to serve as the primary basis for investment decision-making. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.
An IRA should be considered a long-term investment. IRAs generally have expenses and account fees, which may impact the value of the account. Nonqualified withdrawals may be subject to taxes and penalties. Maximum contributions are subject to eligibility requirements. For more detailed information about taxes, consult IRS Publication 590 or a tax professional regarding personal circumstances.
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