IRAs and Roth IRAs offer tax advantages that allow you to save more and give Uncle Sam less over time, but certain actions can trigger major tax bills in a given year. If you have either of these retirement accounts, here’s how to get the most out of them and prepare for any related personal income taxes that you might owe this year.
Maximize Contributions Before Filing Taxes
To get the most benefit from your IRA or Roth IRA, make sure you contribute the full amount that you’re allowed to. The contribution limit for 2019 is $6,000 for people under 50 years old and $7,000 for seniors age 50 or older. This is an individual limit, so spouses can each have their own account and contribute the maximum allowed.
Moreover, these contributions don’t have to be made by the end of the calendar year. As long as you make contributions before filing your 2019 personal income taxes, those contributions can be counted on your return. The deadline for filing this year is April 15, 2020.
Plan for Taxed Roth IRA Contributions
While Traditional IRA contributions are tax-deductible and will lower how much you owe for the year’s income taxes, the same isn’t true for Roth IRA contributions. Whereas contributions made to Traditionals are pre-tax, anything put in a Roth is post-tax income. As a result, you’ll have to pay income taxes on contributions made to a Roth if you haven’t already.
For some people, this is a moot point because contributions are made from paychecks that have already had income tax withheld. If you’re self-employed or use a non-salary/wage income for these contributions, though, make sure you keep enough to pay the income taxes that will be due.
Reserve Some Withdrawals for Taxes and Penalties
Neither IRA or Roth IRA accounts are intended to have money taken out of them before age 59-1/2 , but you can access the funds in your account should you need to for an emergency. For
example, sometimes people make early withdrawals to avoid bankruptcy, prevent foreclosure or pay unexpected medical bills.
Should you take an early withdrawal, you might be hit with a substantial income tax and penalty depending on how much and what exactly you take out. The implications are as follows:
Early withdrawals from Traditional IRAs are taxed at your income tax rate and assessed a 10-percent penalty.
Withdrawn earnings from Roth IRAs are taxed at your income tax rate and assessed a 10-percent penalty.
Withdrawn contributions from Roth IRAs aren’t taxed or penalized, because you’ve already paid income tax on this money.
Because withdrawals are usually made for financial emergencies, they’re frequently substantial. If you made an early withdrawal this year, reserve some of the funds to pay any taxes and penalties that you need to.