Since you have until April 15, 2020, to contribute to your IRAs for the 2019 tax year, use the beginning of 2020 to maximize your retirement planning by learning about new contribution limits, factors to consider, and different types of IRAs.
The first three and a half months of the following year are unique as you can make contributions to IRAs for both the prior and current tax years, and save for retirement. For some, it can seem stressful with tax deadlines like filing estimated payments, taking Required Minimum Distributions (RMDs), and planning Individual Retirement Account (IRA) contributions.
Getting familiar with the rules surrounding IRAs—or, for starters, the rules around contribution limits—can help make saving for retirement easier and less painful.
Contributing to an IRA is important as it will help provide for you during retirement and prevent you from relying on the meager average Social Security monthly payment of $1,344. This guide will show you the factors that impact IRA contributions, how to calculate your IRA tax deduction, different types of IRAs, and changes for 2020.
Of course, for accurate advice on your particular situation, including what your specific options are, consult with a qualified financial professional.
Factors that affect contribution limits
Taxpayers that are older than 70.5 can’t contribute to IRAs. So, if you turn 70.5 in 2020, you can’t contribute to it for the tax year 2020 and beyond. However, you can still contribute to IRAs for the 2019 tax year during the first quarter of 2020.
Remember, turning 70.5 is an important milestone as you have to take Required Minimum Distributions (RMDs) after reaching this age.
Marital or taxpayer filing status can impact tax deduction limits for IRAs. For example, Married Filing Separately (MFS) taxpayers can deduct IRA contributions on their returns if their Modified Adjusted Gross Income (MAGI) is a mere $10,000 or less for the year. Married Filing Jointly (MFJ) and Single Taxpayers have higher IRA contribution limits at $103,000 and $64,000, respectively.
Also, taxpayers older than 70.5 can bypass the age limit by contributing to their younger spouse’s IRA, also known as a spousal IRA deduction.
Most of you can contribute to an IRA, but your income level will either qualify or disqualify that contribution for a tax deduction.
For instance, single filers can have a MAGI of $64,000 or less and receive a full tax deduction up to $6,000 or $7,000 if they’re older than 50. Deductions are pro-rated and eventually phased out once single taxpayers’ MAGIs are greater than $74,000.
What is MAGI and how do I use it to calculate my contribution limits?
Modified Adjusted Gross Income (MAGI) starts out as Adjusted Gross Income (AGI), which is simply gross income minus adjustments and can be found on line 37 of tax form 1040. MAGI adds back adjustments like qualified tuition expenses, half of the self-employment tax, passive income or loss, and more.
Once you have this figure, determine your filing status. If you’re filing single, then you’d qualify for an entirely deductible IRA contribution if your MAGI is less than $64,000. If your AGI is between $64,000 and $74,000, then the deduction would be prorated.
Here’s a simple scenario:
You’re a single taxpayer who has a MAGI of $68,000. You’d take the upper limit of $74,000 and subtract your MAGI to get $6,000. Multiply $6,000 by 55% if you’re under the age of 50 to get your maximum IRA tax deduction of $3,300. If you’re older than 50, you’d multiply that difference by 65%.
Keep in mind that partial deductions are impacted by tax filing status, employer-sponsored retirement plan contributions, and more. Use Worksheet 1-2 in IRS Pub 590 to correctly calculate your partial IRA deductible contributions.
Breakdown of the different IRA types and their 2019 contribution limits
Traditional IRAs allow you to contribute up to $6,000 ($7,000 if you’re older than 50) per year. You can receive a tax deduction based on your MAGI, age, and filing status. MAGI limits can vary from as little as $10,000 for Married Filing Separately up to $124,000 for Married Filing Jointly. Most taxpayers, excluding those older than 70.5 or have earned income less than the total annual contribution, can allocate funds toward IRAs.
Roth IRAs are unique as you can contribute up to $6,000 ($7,000 if you’re older than 50) per year with after-tax dollars. The funds grow tax-free and Roth IRAs have more flexibility since you can access your contributions without penalty after 5 years and you don’t need to take RMDs from this account. Roth IRAs have similar contribution limits to Traditional IRAs, but you won’t be able to make any contributions once your MAGI surpasses certain thresholds
Note that the total annual combined deduction for Traditional and Roth IRAs is $7,000, so you can’t contribute $7,000 to each account.
SEP IRAs are retirement accounts for small businesses and the self-employed. These entrepreneurs can contribute either the lesser of $56,000 or 25% of their net self-employment income on a pre-tax basis.
SIMPLE IRAs are like SEPs as they are retirement accounts for the self-employed and small business owners. The contribution limit is $13,000 with a $3,000 catch up allowed for those over 50. The biggest difference between SIMPLEs and SEPs is that both employers and employees can contribute to a SIMPLE with SEPs only permitting employer contributions.
Prognosis for 2020
Luckily, 2020 won’t have many changes regarding IRA contributions and limits. For instance, contributions will slightly increase as can be seen from the SEP IRA limit increase to $57,000 in 2020. SIMPLE IRA limits will increase to $13,500 from $13,000 in 2019. MAGI limits will gradually increase by roughly $1,000 as the single MAGI limit will increase to $65,000 from $64,000.
Alongside these minimal changes, you should be mindful of your age, employment status, MAGI, and filing/marital status as you work on investing in an IRA.
You can better prepare yourself for a successful retirement by learning about important items that impact IRA contributions. Besides this, you can learn about how to properly calculate your tax-deductible IRA contribution, diversify your retirement plan with different IRA types, and anticipate changes for 2020.