BY JOE KRISTAN, CPA, Partner, Eide Bailly
We think in deadlines from the time we get our first homework assignment. The first question is always “when is this due?” I don’t remember anyone asking for the soonest date we could turn in a paper. Anyone who did would surely have been an outcast among my classmates.
Still, sometimes early is better. When the tax law lets you defer tax on investment income, you want to get started right away, rather than wait for the last possible day. That’s even more true if you can avoid tax on that income forever.
Here are some savings tools where tax rules make it worthwhile to get in over the 2020 startline instead of under the deadline.
Individual retirement accounts (IRAs). These are among the oldest tax-advantaged retirement savings tools for individual taxpayers. Taxpayers can contribute the lesser of their “earned income” or $6,000 for 2020 to these accounts. Taxpayers who reach age 50 before the end of 2020 can throw in an extra $1,000.
These come in two basic flavors: “Traditional” and “Roth.”
Traditional IRAs accumulate earnings without current tax, but the earnings are taxable when withdrawn. If neither you nor your spouse are covered by a retirement plan at work, you can deduct your contribution without itemizing. For 2020 taxpayers covered by a qualified plan at work, the deduction phases out starting at $65,000 Adjusted Gross Income (“AGI”) for single filers and $104,000 for joint filers. If you don’t qualify for the deduction, you still get a tax deferral for your earnings until you withdraw them.
Roth IRAs don’t generate a current tax deduction, but their earnings are never taxed if certain relatively easy requirements are met—primarily that you leave the money alone for five years. The only catch is that contributions to Roth IRAs are limited for higher-income taxpayers. For joint filers, the deduction begins to phase out at $196,000 of adjusted gross income, and for single filers starting at $124,000. And even over these limits, you may qualify for a “backdoor” Roth IRA contribution.
For both flavors of IRAs, the contribution deadline for 2020 is April 15, 2021, but we’re more worried about the startline. The startline—the first day you can make a 2020 IRA contribution—is January 1, 2020. IRA contributions made at the startline build up tax-free for 15 ½ months longer than those made at the deadline.
If you somehow missed the 2019 startline, 2019 IRA contributions must be made by April 15, 2020.
Education Savings Sec. 529 plans have similar incentives to Roth IRAs: no deduction, but no tax on investment income if the funds are used for qualifying education costs. These plans are designed to help build tuition nest eggs. Iowa’s version of the plan, College Savings Iowa, offers an additional benefit: a deduction on your Iowa tax return.
The maximum Iowa-only deductions for 2020 College Savings Iowa contributions haven’t been announced yet, but it will not be less than the 2019 deduction of $3,387 per donor, per-donee. Assuming a round $3,400 limit for 2020, a married couple with two children can deduct $13,600 in CSI contributions on their 2020 returns for their kids’ Section 529 college funds. There is no penalty for over-contributing, as long as you stay within the federal government’s lifetime funding limits; you just don’t deduct the excess. If you exceed $15,000 per donor, per donee, there may be gift-tax return requirements. There are no income limits for Sec. 529 contributions. The startline for 2020 contributions to College Savings Iowa is January 1, 2020. If you haven’t made your 2019 contribution yet, the deadline for that is April 30, 2020.
Health Savings Accounts provide a current deduction and the possibility of tax-free withdrawals for qualifying out-of-pocket medical expenses. Full deduction and tax-free withdrawals are a combination rarely found in the tax law. So of course, there are catches.
You can only make contributions to Health Savings Accounts if you have a qualifying high-deductible health insurance plan, and only to the extent it isn’t funded by your employer. Anyone enrolled in Medicare, or any other health plan, is ineligible, as is anyone claimed as a dependent on another taxpayer’s return or over the age of 65.
For taxpayer-only coverage, the 2020 contribution limit is $3,550, requiring an annual policy deductible of at least $1,400. For family coverage, the limit is $7,100, requiring a deductible of at least $2,800. There are no income limits for HSA contributions or deductions. Taxpayers who reach age 55 by the end of 2020 can contribute an additional $1,000.
Earnings on investments in an HSA accumulate tax-free, like an IRA. All HSA withdrawals for qualifying medical costs are tax-free. For taxpayers who reach Medicare eligibility, withdrawals for non-medical expenses are taxed like Traditional IRA withdrawals.
The startline for 2020 HSA contributions is January 1, 2020. If you only have qualifying coverage for part of 2020, your deduction will be prorated for the number of months you have that coverage. Since a penalty applies to excess contributions, you want to be confident that you will have qualifying coverage all year if you fund the whole year on January 1.
If you haven’t made your 2019 HSA contributions yet, your deadline is April 15, 2020.
All of these tax savings plans are subject to many technical rules, so consult your tax advisor before committing your money. But if you do qualify, sooner is better—maybe 15 ½ months better.
| Joe Kristan