Since deferring income into another year is no longer an option, retirement contributions are a great way to reduce adjusted gross income (AGI). Some options include IRAs and retirement savings to lower taxes.
IRA and Retirement Savings Rules that Can Lower Taxes
Maximize Retirement Savings: In many cases, employers will require you to set your 2020 retirement contribution levels before January 2020. If the maximum §401(k) contribution for 2019 was not selected, you may be able to increase contributions for the remainder of 2019 to lower AGI in order to take advantage of some of the tax breaks described below. Maximizing retirement contributions generally is a good tax-saving move.
Traditional IRAs: If you are not an active participant in an employer pension plan you may make deductible contributions to an IRA. The deadline for 2019 contributions is April 15, 2020. The annual deductible contribution limit for an IRA for 2019 is $6,000. A $1,000 “catch-up” contribution is allowed if you are age 50 or older by the close of 2019, making the total limit $7,000. If you are an active participant in an employer pension plan you may be able to make a deductible contribution to an IRA, but your contributions are limited in amount depending on your AGI. For 2019, the AGI phase-out range for deductibility of IRA contributions is between $64,000 and $74,000 of modified AGI for single persons (including heads of households), and between $103,000 and $123,000 of modified AGI for married filing jointly. Above these ranges, no deduction is allowed.
In addition, you will not be considered an “active participant” in an employer plan simply because your spouse is an active participant for part of a plan year. You may be able to take the full deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if your joint modified AGI is $193,000 to $203,000 for 2019. Above this range, no deduction is allowed.
IRA Rollovers: For 2019, you may make only one IRA-to-IRA rollover per year. (Direct trustee to trustee rollovers are not affected.) A second attempted rollover will be treated as a withdrawal and taxed at regular rates, plus a possible 10% early withdrawal penalty.
Spousal IRA: If you file a joint return and have less compensation than your spouse, your IRA contribution is limited to the lesser of $6,000 for 2019 plus age 50 catch-up contributions ($1,000 for 2019), or the total compensation of both spouses reduced by the other spouse’s IRA contributions (traditional and Roth).
Roth IRA: This type of IRA permits nondeductible contributions of up to $6,000 ($7,000 if making eligible catch-up contribution) for 2019, but no more than your compensation. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and you have reached age 59 1/2. Distributions may be made earlier if you become disabled or upon death. The maximum contribution is phased out in 2019 if your AGI is above $193,000 to $203,000 for married filing jointly, $122,000 to $137,000 for single taxpayers (including heads of households), and between $0 and $10,000 for married filing separately who lived with the spouse during the year. A Roth IRA must be established and funded by April 15, 2020 for a 2019 contribution.
Roth IRA Conversion Rule: Funds in a traditional IRA (including SEPs and SIMPLE IRAs), §401(a) qualified retirement plan, §403(b) tax-sheltered annuity, or §457 government plan may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied.
You should also potentially consider a “back door” Roth IRA if you are a high-income earner, especially if your income is higher than the maximum the IRS allows for regular Roth contributions. This is where you set-up a traditional IRA account, make a nondeductible contribution and then convert the traditional account to a Roth account. The only tax due would be on any growth in the account between the time you made the contribution and the date of the conversion.
Section 401(K) Contribution: The §401(k) elective deferral limit is $19,000 for 2019. If your §401(k) plan has been amended to allow for catch-up contributions for 2019 and your age 50 by December 31, 2019, an additional $6,000 may be contributed to your §401(k) account, for a total maximum contribution of $25,000 ($19,000 in regular contributions plus $6,000 in catch-up contributions).
SIMPLE Plan Contribution: The SIMPLE plan deferral limit is $13,000 for 2019. If your SIMPLE plan has been amended to allow for catch-up contributions for 2019 and your 50 years old by December 31, 2019, an additional $3,000 may be contributed.
Catch-Up Contributions for Other Plans: If you will be 50 years old by December 31, 2019, an additional $6,000 can be contributed to a §403(b) plan, SEP, or eligible §457 government plan.
Required Minimum Distributions: For 2019, if you are at least 70 1/2 you must take a required minimum distribution (RMD) from IRAs or defined contribution plans (§401(k) plans, §403(a) and §403(b) annuity plans, and §457(b) plans that are maintained by a governmental employer). The distribution must be taken by December 31, 2019. However, if you’re turning 70 1/2 during 2019, the first distribution is not required until April 1, 2020. For all subsequent years, including the year in which you were paid the first RMD by April 1, you must take the RMD by December 31 of the year.