An IRA Extension: A Gift from the Internal Revenue Service
April 20, 2020 Author: Tess Downing, MBA, CFP®, Complete View Financial
Everybody’s been hit. Somehow.
The shutdown of America has hit every one of us and changed every aspect of our lives.
For some, it’s in having to learn to school our children. For others, it’s having everyone home because offices and businesses are closed. Or because jobs have been lost.
For some, the disruption takes the form of significant inconveniences, and for others, it’s a liquidity problem. Or both.
And the lack of clarity of how things will move forward again is disorienting.
Your stimulus money
One small piece of support from the federal government is the stimulus money that started appearing in bank accounts last week. This could be $1,200 for an individual or $2,400 for a couple filing jointly, plus $500 for every dependent child under age 17. (And, yes, there are income phaseouts: benefits go down as income goes up.)
Your priority is protecting yourself and your loved ones. If you lost your primary source of income – by losing your job or having to shut down your business – keeping a roof overhead and food on the table is Job #1. That’s where the stimulus money should go.
But if liquidity is not an issue, there’s another possibility.
We’re all going to retire someday
Eventually, our economy will start back up again. Life may look different, but we’ll work, marry, have babies, start businesses – and eventually retire.
So, if we can avoid it, there’s merit in not taking our eye off our retirement goals.
The markets will eventually right themselves. (We might have to realign our asset mix.) Time will continue to be a powerful factor when it comes to compounding. And IRAs will continue to be one welcome pillar of our retirement mix.
A gift from the IRS
Because of all the disruption, the Internal Revenue Service has extended the 2019 personal tax filing deadline from April 15 to July 15 this year. It did the same thing for IRA contribution deadlines.
So, if you haven’t contributed to IRAs for 2019, you’ve been given another chance.
Does it make sense to contribute to an IRA in this disrupted economy?
From a market perspective, we have no way of knowing if they have reached some kind of bottom and will head back up as the economy reopens. Or if they can still tumble lower. But considering many people contributed while the markets were much higher last year, this could serve as a form of dollar-cost averaging.
And from a tax point of view? This stimulus money is coming as a tax refund, so it is tax-free. But, if you had any other income in 2019, a contribution to a traditional IRA can be used as a deduction against that income. As such, you are increasing the value of your stimulus by the tax rate you pay. And if you don’t need the deduction and choose to contribute to a Roth IRA instead, the money will grow tax-free and can be withdrawn in retirement tax-free.
Is this your first IRA contribution?
If so, let’s look at some basics.
Contributions can be to traditional IRAs or Roth IRAs.
You can fully or partially deduct the money you contribute to a traditional IRA from the income you report for that tax year, say 2019. Since you haven’t paid taxes on that income, the tax portion is allowed to grow in your IRA as well.
When you withdraw the funds from your IRA, you will pay taxes on the original funds and the gains. (If you withdraw before age 59½, you’ll also pay a penalty.)
The theory is that your tax rate will be higher now than in retirement, so your tax burden will be lower then. Timing the withdrawal from IRAs is part of a well-designed retirement strategy.
Your contribution to a Roth IRA is not deductible from your income, so you don’t get a tax break up front. Your money does grow tax-free, though. If you follow the IRS’s rules, you can withdraw the funds in retirement tax-free. And there are lots of reasons to want tax-free income in retirement.
When the federal government lets you defer the payment of taxes, it misses out on collecting tax revenues. So, it puts a cap on how much you can contribute.
The limit for tax years 2019 and 2020 is a total of $6,000 (or $7,000 if you are 50 or older) in whatever combination of traditional or Roth accounts, or both. It doesn’t matter how many accounts you open, that is the total contribution allowed.
You also can’t contribute more than you have in ‘earned income’ that year. Earned income is defined as taxable employee compensation, net earnings from self-employment, and specific disability. It doesn’t include Social Security, pensions, annuities, alimony, child support, rental income, investment income, income, royalties, and such.
And you might be limited by your income, filing status, and having other retirement plans.
If you’re not sure how much you can contribute, you might want to check with a financial advisor or your IRA’s custodian (that’s the brokerage or bank that holds your IRA).
When can you contribute to IRAs?
You can contribute any time during a tax year, and up to April 15 of the next year and still have it count. (The July 15 deadline is an exception.)
And, because of changes in the SECURE Act of 2019, starting in Tax Year 2020, we are no longer limited to contributing to traditional IRAs up to age 70½. As long as we have earned income, we can keep contributing.
So, why do it?
Anything we do that provides a sense of continuity is good. And contributing to an IRA is ‘future-looking.’
The yearly caps on IRA contributions – at $6,000 or $7,000 – may not make them seem that meaningful. But in witnessing the retirement process, we know they add up and grow with the years.
In retirement, you’ll be glad you did so – way back in 2020.
If we can help you with this decision – or anything else related to how all these disruptions might affect your retirement strategies – feel free to call Complete View Financial for an initial consultation.
And for more information about a Roth conversion which refers to the act of converting a traditional IRA account into a Roth IRA account read our article here.