The extension of the individual income tax return due date provides taxpayers more time to take advantage of several tax savings strategies.
Recently, the IRS announced that the deadline for filing individual tax returns would be extended to May 17, 2021. This allows individuals covered by high deductible health plans (HDHP) to contribute to a Health Savings Account (HSA) until May 17 and make additional 2020 contributions. Further, contributions to 2020 IRAs and Roth IRAs can be made until the May date.
So, can this extension benefit you? If you take advantage of the extra time to contribute, you will likely see not only tax savings but long-term benefits including:
HSA contributions can be used to cover out-of-pocket medical, dental and vision expenses. The earnings of HSA accounts are not taxed, as long as the funds are used for qualified medical expenses, for withdrawals now and in the future. In fact, some individuals choose to use this type of account to pay for medical expenses in retirement by contributing each year and investing the funds but not withdrawing until they retire.
HSA limits for the 2020 tax year include $3,550 for individual coverage and $7,100 for families. Taxpayers over the age of 55 can also contribute an extra $1,000 to their plan. If you have not fully funded your 2020 HSA, now is the time to do so.
Roth IRA and IRA Contributions
Roth IRAs are a great investment tool for all taxpayers. While Roth IRA contributions are not deductible, earnings build tax-free and can be a great retirement asset. Some taxpayers also qualify for a saver’s credit against their taxes based on their retirement contributions, which includes Roth IRA contributions.
A Roth IRA for income earning children is a strategic way to help your children start to learn about investing, all while saving for retirement. Contributions to a Roth IRA equal to the lesser of earned income or $6,000 can be made for income earning children and grandchildren and will grow tax-free.
While it is ideal to leave Roth IRA funds invested until retirement, withdrawals are considered to be first from contributions, and are tax-free until all contributions have been withdrawn.
When distributions exceed contributions, the earnings are distributed. If the distribution is “qualified,” the portion from earnings is not subject to income tax. Qualified distributions are those made at least five years after the initial Roth contribution and after age 59 ½. Distributions used for a first home purchase, made at least five years after the initial contribution, are also considered qualified distributions.
Nonqualified distributions are subject to income tax and a 10 percent penalty to the extent they exceed contributions. Nonqualifying distributions used for certain medical expenses and qualified education expenses are still subject to tax; however, they avoid the 10 percent penalty.
Before May 17, you can contribute to your Roth IRA, IRA or a combination of both for 2020 as long as you don’t exceed your annual total IRA limit of $6,000 (or $7,000 if over the age of 50). Taxpayers, who are unable to contribute to a deductible or Roth IRA due to income limits, can still fund their retirement accounts using the strategy best known as a “backdoor Roth IRA.” This would consist of contributing to a nondeductible IRA and then converting the account to a Roth IRA. There are a few caveats to this process that can be found here.