- Some investors may score a federal write-off for their traditional individual retirement account contributions up to a limit.
- However, the tax break depends on participating in a workplace retirement plan, such as a 401(k) plans or pension, and income.
- Those who can’t deduct their IRA contributions may have other options, financial experts say.
As the year winds down, those looking to trim their tax bill may consider an individual retirement account contribution. Before transferring the funds, however, there are rules and limits investors need to know, financial experts say.
"Anyone can contribute to a traditional IRA — you, me, Jeff Bezos," said certified financial planner Howard Pressman, partner at Egan, Berger & Weiner in Vienna, Virginia.
However, the ability to write off IRA contributions depends on two factors: participation in workplace retirement plans and income.
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For 2021, someone may deposit up to $6,000 into their IRA ($7,000 for someone age 50 or older), provided they have earned that much income, anytime before the tax-filing deadline.
An investor and their spouse may be "in the clear" to write off their entire IRA contributions if both spouses aren't participating in an employer's retirement plan, said Larry Harris, CFP and director of tax services at Parsec Financial in Asheville, North Carolina.
However, the rules change if either partner has coverage and participates in the plan, including deposits from the employee or company.
For example, participation may include employee contributions, company matches, profit sharing or other employer deposits.
Single investors using a workplace retirement plan may claim a tax break for their entire IRA contribution if their modified adjusted gross income is $66,000 or less.
While there's still a partial deduction before they reach $76,000, the benefit disappears once they meet that threshold.
Married couples filing together may receive the full benefit with $105,000 or less, and their partial tax break is still available before reaching $125,000.
There's an IRS chart covering each of these limits here.
Spouses who don't work outside of the home may also contribute based on the income of the earning spouse, in what's known as a spousal IRA, Pressman added.
"This also has income limitations, but they are higher than those for workers covered by a plan," he said.
While some investors won't qualify for IRA contribution deductions, there are other options to consider.
Non-deductible IRA contributions are a popular choice because some investors may qualify to convert the after-tax deposit to a Roth IRA, known as a "backdoor" maneuver, bypassing the income limits.
However, the tactic may be on the chopping block.
House Democrats want to crack down on the strategy, regardless of income level, after Dec. 31, according to a summary released by the House Ways and Means Committee.
But with the budget in flux, it's unclear if the provision will make it through negotiations.
Other options may include maxing out a workplace retirement plan, including catch-up contributions for those who are age 50 and older, Pressman suggests.
After that, someone may consider investing in low turnover index mutual funds in a regular brokerage account.
"This account will not be subject to retirement rules, limiting your access to the funds, and when you take distributions your growth will be taxed at more favorable capital gains tax rates rather than higher ordinary income rates of IRAs," he added.
"While you will need to pay taxes on capital gains and dividends each year, using index funds with low turnover should keep these taxes to a minimum," he said.