A Late Save

Richard Connor

MANY RETIREMENT savers fund tax-deferred accounts—with good reason: The money we contribute pre-tax to an IRA or 401(k) reduces our taxable income, plus that money grows tax-deferred until withdrawn.

But there are two lesser-known benefits that are worth keeping in mind. First, with IRAs and solo 401(k)s, you can contribute for last year right up until the tax-filing deadline in April of the following year. That means you can calculate your tax bill, make an IRA contribution that’s credited to last year—and voila—cut the tab you owe Uncle Sam. It’s like time travel for tax breaks.

I’ve used this strategy several times, including for 2022’s tax year. I’m self-employed and have a solo 401(k). My consulting income has fluctuated over the past five years. Often, the bulk of it arrives in the last quarter of the year. That makes a belated solo 401(k) contribution a good lever to pull to avoid unexpectedly high tax bills.

There’s an added benefit if you’re over age 59½. Any contributions made for a prior year can be immediately withdrawn penalty-free if you need the cash. To be sure, the withdrawal would be considered taxable income, but that may make sense if you expect to be in a lower tax bracket in the current year.

Unfortunately, after Dec. 31, you can’t make a contribution to a regular employer-sponsored 401(k) plan for the previous tax year. What to do? Up until the tax-filing deadline in April, you could instead contribute to a traditional IRA for the previous year, though your contribution won’t necessarily be tax-deductible.

That brings me to a second tax break—one for low- and middle-income savers that I wish more people knew about. The retirement savings contribution credit, or saver’s tax credit, rewards workers for funding retirement accounts by giving them money back for their contributions. The credit depends on income. If you qualify, it can be 50%, 20% or 10% of the sum saved up to $2,000.

That means the maximum credit an individual might earn is $1,000, or 50% of his or her $2,000 contribution. You can save more, of course, and probably should. You just won’t get extra tax credit for the dollars over the $2,000 threshold.

To qualify for the saver’s tax credit in 2023, a single filer can have an adjusted gross income of up to $36,500 and a married couple up to $73,000. What if you’re just above the qualifying line? Tax-deductible retirement savings might drop your income enough to make you eligible. That’s because retirement contributions are subtracted from gross income when calculating adjusted gross income.

I’ve put this credit into play several times while volunteering with a local VITA tax preparation site. In one case, the client was a 60-year-old widow with a modest income from a part-time job. In 2022, she worked more than she expected but didn’t have any taxes withheld. She owed approximately $2,500 when we filed her return.

Later, she asked why she owed such a relatively large amount, and how to prevent it from happening again. I reviewed her return and found one solution was to have her employer withhold taxes at the rate of about 7% of her income. There was a second way to go, however.

She hadn’t made any IRA contributions in 2022. I asked if she had an IRA and money to contribute to it. I explained that she was eligible for a tax deduction on the amount contributed, and likely a saver’s credit on top of that. This was the week before this year’s April 18th tax filing deadline, so time was of the essence.

She thought she had an IRA and was confident she had money to contribute. Since she was over age 50, her maximum allowable IRA contribution for 2022 would be $7,000. That limit climbs to $7,500 for 2023. I suggested she contact the IRA administrator and confirm it would accept a contribution for 2022 before the deadline. If so, I could submit an amended 2022 tax return for her.

She left somewhat confused about the credit and concerned that the tax-filing deadline was looming. Unfortunately, she didn’t come back. I’m not sure she completely understood the strategy. I also recommended that she have her return completed earlier next year, so there’d be more time to make adjustments. I hope she follows through.

Had she been able to make a timely contribution for 2022, the revision to her tax forms would have been simple. Her total taxes owed would have been reduced by the amount of the contribution multiplied by her marginal tax rate. Her revised adjusted gross income would also be used to determine her eligibility for the saver’s credit. The credit, if she had qualified, would have further reduced the amount of taxes she owed.

This strategy has the potential to work well for many low-wage earners, either early in their careers or possibly in retirement. You don’t have to go whole hog to get the benefit, as the table below shows.

Single workers earning $35,500 in 2022 could have reduced their taxes from $2,501 to $2,061—a savings of $440—by contributing $2,000 to an IRA. Under the same scenario, if they could have afforded to contribute $7,000, their tax bill would have dropped to $1,461, for a total savings of $1,040.

Do you have a grandchild just graduating from high school and not going straight to college? I previously wrote an article explaining how a parent or grandparent could contribute to a child’s Roth IRA. As long as the grandchild meets the eligibility criteria for the saver’s credit—age 18 or older, not a fulltime student and not anyone’s dependent—he or she should qualify for the credit. A grandchild who enlists in the military after high school would be a great candidate for this strategy—and for some family financial support.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.

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