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Not Too Late

Richard Connor  |  March 23, 2020

WE OFTEN PREPARE our taxes, only to learn we owe a substantial sum to Uncle Sam. Most of us believe we can’t do much about this—and yet there’s one simple fix available to many taxpayers: Make a tax-deductible retirement account contribution this year for 2019.

Indeed, thanks to the stock market’s decline, this is a great time to shovel more money into your retirement accounts—and you may discover you can add to more than one account.

Retroactive contributions. Typically, the IRS allows taxpayers to contribute to qualified retirement accounts—think IRAs, 401(k)s, 403(b)s—up until the tax-filing deadline and still claim a deduction for the prior year. For instance, you might add to an IRA today and deduct the contribution on your 2019 tax return. Some employers also allow retroactive contributions to their 401(k) or 403(b) plans. In addition, you might be able to make prior-year contributions to a health savings account.

Because of the coronavirus, the filing deadline for 2019 tax returns has been extended from April 15 to July 15. The IRS announced that the deadline for retroactive contributions to tax-favored accounts has also been extended to July 15.

Worried that you may owe taxes for 2019? Contributing to a qualified retirement account will reduce your taxable income and thus trim your tax bill. This is true whether you itemize your deductions or claim the standard deduction. Don’t currently have an IRA? No problem. You can open an IRA today and have your contributions apply to the previous year’s taxes.

Spousal IRA. To fund a qualified retirement account, the person contributing typically needs earned income, meaning income from working, as opposed to investment income. One exception is the spousal IRA.

This is a great opportunity for couples where one spouse has little or no earned income. In effect, the working spouse provides the earned income required to make contributions for both spouses. To qualify, the couple must file a joint tax return.

Sometimes, if the working spouse has a retirement plan at work, this can prevent a couple from deducting their IRA contributions. But in all likelihood, both spouses can still claim the deduction, because the income limits are fairly generous: For couples, the ability to fund tax-deductible IRAs phases out for 2019 at modified adjusted gross incomes of $193,000 and above.

Tax-rate arbitrage. I volunteer for AARP’s Tax-Aide program, where I help older Americans do their taxes. The program is on hold right now, because of the coronavirus, but I hope it’ll return before the tax season is over.

While working at Tax-Aide earlier this year, before the shutdown, I had a client who works in a local school district and has a 403(b), but didn’t maximize her 2019 contributions. She has a nice salary and ended up in the 24% marginal tax bracket. She plans to retire in June. Her federal tax return showed a tax bill of about $1,000.

We pointed out that she still had time to contribute to her 403(b) or an IRA. For each $1,000 she contributed, she would save $240 in 2019 federal taxes. A $4,000 contribution would nearly wipe out her tax bill.

Moreover, since she’s planning to retire this year, her marginal tax rate in 2020 and beyond is likely to be lower than her 2019 rate. The upshot: She could deposit the funds now, get the tax deduction for 2019 and then withdraw the money later in the year if she needs it. The $4,000 withdrawal would be taxed at a rate that’s lower than the 24% rate at which she’s claiming the deduction—a nifty piece of tax-rate arbitrage.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles include Cheat SheetsChoosing Life and Step by Step. Follow Rick on Twitter @RConnor609.

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