Because of the COVID-19 crisis, the federal government announced that it would extend the deadline for filing 2019 tax returns from April 15 to July 15 so that people can hold on to cash that they may need. The decision also provides individuals more time to prepare their returns and their tax payments in a situation that has created financial disruption in many families.
People across the country are experiencing financial stress, with record numbers of people applying for unemployment and many more struggling with sudden reduction in income. While the decision to push back the tax deadline will undoubtedly help many Americans, it also comes with some perks for people who are not strapped for cash and could boost retirement savings for these individuals.
Taking Full Advantage of the Extended Tax Deadline
In a typical year, contributions to an individual retirement account (IRA) made on or before April 15 can be counted toward the prior year. Once taxes are due, contributions must be counted for the current year. This is beneficial for people who have not maxed out their IRA contributions.
In 2019, the maximum contribution is $6,000 per person with the additional catch-up allowance of $1,000 for people at least 50 years old. Taxpayers who do not have an employer-sponsored plan can deduct full contributions to an IRA. Others receive some tax benefit that is phased out depending on overall earnings.
As a general rule, people should also focus on maxing out the prior year before they start making contributions toward the current year. This provides more flexibility in the months to come. The new filing date for 2019 taxes means that individuals have an additional three months to max out their contributions to IRA accounts before they start their 2020 contributions.
Individuals who are still able to contribute to an IRA should make sure they file contributions under 2019 so that they do not meet the 2020 limit earlier than expected. This strategy is especially beneficial for people who expect to earn less in 2020 than 2019. Earmarking the contributions for 2019 reduces taxable income for 2019.
Smart Saving Moves in the Current Economic Climate
The current economic situation should encourage people to step back and reevaluate their savings strategy for retirement. Because of stock market volatility, people may want to consider favoring a Roth account more than they have in the past. This is because the current market is more than 20 percent below its highs.
Money that is invested in a Roth IRA is permitted to grow from these lower prices without any increased tax liability on that growth. Of course, contributions to a Roth IRA are not tax deductible. Additionally, people need to meet certain eligibility requirement before they are allowed to start putting money in them.
However, since contributions to a Roth are made with after-tax income, eventual withdrawals are tax-free as well. Importantly, spouses who do not earn income can also make contributions to a Roth IRA, which could be another way of boosting savings.
The federal government also recently approved a $2 trillion stimulus package that will give individuals up to $1,200 in direct relief amid the COVID-19 crisis. People who are already in a stable financial situation should consider using this windfall as a jumpstart for their IRA contributions.
Importantly, individuals who have already filed a 2019 return can still contribute money in an IRA toward the limits of the prior year. Doing so will require filing an amended return if individuals want to deduct the contribution from their net income. However, individuals also have the option of considering the contribution a nondeductible addition, which also applies to people who have maxed out the allowable deduction based on income.
Investors should take the time to check in with their IRA custodians to make sure that contributions are counted toward the correct year. This will be particularly important after April 15, when systems may default to 2020 contributions.
Points to Keep in Mind about the New Tax Situation
Importantly, the same rules do not apply to 401(k) accounts. Savers who want to take advantage of the unique tax situation need to already have an established IRA or Roth IRA to do so.
The extension also applies to health savings accounts (HSAs). This means that individuals can also maximize contributions to these accounts for 2019 before switching to 2020 allocations. Those who want to minimize their tax liability for 2019 should take note of the HSA rules as they can use additional contributions toward this account to reduce net income as the allocations are tax-deductible.
Investors may want to talk to a financial expert to get personalized advice about how to take full advantage of the unique tax situation. This will help ensure that any actions they take with their investments will benefit them in the long run.
Of course, these tax moves are not for everyone. Those who are in difficult financial situations due to reduced income or job loss should hold onto their money so they have cash to deal with monthly expenses. People who believe that their jobs are at risk and have not yet created an adequate emergency fund needs to prioritize this goal.
If the situation changes radically in the coming couple of months, people can always make contributions to 2019 IRA savings very close to the July 15 deadline once they know that their finances have stabilized.