Individual retirement accounts (IRAs) are not only great tools for saving and investing for retirement, but they're also great tools for tax planning. Here's what you need to know about these plans, their contribution limits, and their contribution deadlines.
Contribution deadlines align with the tax filing deadline of April 15. However, the IRS tax filing deadline is extended to June 15, 2021, for Texas, Oklahoma, and Louisiana because of the 2021 winter storm disaster areas declared by emergency authorities. This means that IRA contributions are extended for taxpayers in these areas as well.
The Difference Between Traditional and Roth IRAs
There are two types of IRAs: traditional and Roth. Both types offer tax-deferred growth within the accounts and follow the same rules for annual contribution limits. But they differ in the way they are treated for tax purposes.
Traditional IRAs offer a tax deduction on pre-tax contributions and tax-deferred growth for the future. Roth IRAs let you invest post-tax money in a tax-deferred account. This allows you to receive your distributions tax-free when you retire. Roth IRAs have income and filing status limits, while traditional IRAs do not. Other rules also apply to each one.
Other plans might reduce the amount you can contribute, and your deductions might be limited. For example, you might not be able to deduct all or some of your contributions to a traditional IRA if you have a retirement plan at work. Whether you can take a full or partial deduction or none at all depends on your income and filing status.
IRA Contribution Limits
You can contribute to your IRA at any time. You can make several small contributions over the year or in one lump sum. Contribution limits change every year based on inflation and changes in the law.
To be counted as a contribution for the prior year, you have to place your money in the account by the tax filing deadline for that year. For example, if you have a traditional IRA, you have from January 1, 2021, to April 15, 2022, to place money in your IRA and count those contributions on your 2021 tax return. Any amount put into the account after April 16, 2022, must be counted on your 2022 taxes.
You have over 15 months ( January 1 to April 15) to contribute to your IRA for one tax year.
The same deadlines and limits apply to spousal IRA contributions. These allow working spouses to make an additional IRA contribution on behalf of a non-working spouse.
The Internal Revenue Service (IRS) sets combined contribution limits that apply across all IRAs you have. The maximum IRA contribution limit for both types combined is $6,000 for the 2020 and 2021 tax years. However, you can place an extra $1,000 per year ($7,000 total) in your account if you'll be age 50 or older by the end of the year.
You can have as many accounts as you want of either type, but you can only contribute up to the limit per year. You can divide contributions between your IRAs in any way you like. For example, you could put $3,000 in a traditional IRA and $3,000 in a Roth IRA if you're younger than 50. You could also put all $6,000 in a traditional IRA and nothing in your Roth.
IRA and Roth IRA Conversions
You can convert funds between the two types of accounts. This is called a conversion contribution by the IRS, and there is no limit to how much you can convert. It also does not count as a contribution.
This is because those IRA assets would already have been counted for previous years, so Roth conversions aren't subject to the same limits as IRA and Roth IRA contributions.
However, there are taxes involved in one type of conversion. Traditional IRAs are funded using your pre-tax dollars. Taxes on the money you contribute are deferred until you make withdrawals. A conversion is not a contribution, but Roth IRA contributions are taxed before they are placed into the account. This means that you'll need to pay taxes on some or all of the amount you're converting to a Roth IRA.
The Tax Cuts and Jobs Act of 2017 got rid of the ability to convert from a traditional IRA to a Roth IRA and back again. Once a traditional IRA is converted, it cannot be recharacterized (reconverted to a Roth). This applies to all conversions done after January 1, 2018.
There might come a time when you are thinking of converting a Roth IRA to a traditional one. There are again no limits to how much you can convert. However, there are some tax implications to think about. You're moving money that you have paid taxes on to an account that will require taxes to be paid when you begin withdrawing from the account.
The only time this might make sense is if your situation has changed. The taxes you pay now on your Roth contributions would have to be more than the taxes you'd pay on your withdrawals from a traditional IRA for this to work out in your favor. For instance, say you have a Roth IRA and are in the 24% tax bracket. You find a new job that pays much better and find yourself in the 32% tax bracket.
You know that you're only going to withdraw and earn enough to place you in the 22% tax bracket when you retire. It would make sense to roll your Roth IRA into a traditional IRA in this case because you'll pay fewer taxes when you retire and begin taking withdrawals.
- You can typically deduct your contributions to a traditional IRA on your taxes. Your contributions aren't deductible with a Roth IRA, but you can withdraw them tax-free in retirement.
- The contribution deadline for each year is usually April 15 of the following year.
- There's a limit on how much you can contribute: $6,000 in total across your IRAs for the 2020 tax year, or $7,000 if you're age 50 or older.
- You can convert between the two types under certain conditions.