The IRS has extended the April 15th deadline for filing and paying 2020 federal individual income taxes to May 17th. This extended deadline also applies to making 2020 IRA contributions. With all the rush to file your return on time, have you considered making your IRA contributions yet?
Here are 2 main reasons to contribute to an IRA/Roth IRA now:
1. Give your money a chance to grow.
The earlier you start contributing, the more opportunity you have to build wealth. Eligible taxpayers can contribute up to $6,000 per year, or your taxable compensation for the year (whichever is less), to a Traditional or Roth IRA, or $7,000 if they have reached age 50, for both tax years 2020 and 2021 (assuming they have earned income at least equal to their contribution*). While one year’s contribution may not seem exceedingly high, it certainly adds up over time.
Please also keep in mind that if your spouse is not working or is not a US person, you may also be able to make a contribution for them!
*US expats must have earned income that is not excluded by the Foreign Earned Income Exclusion (FEIE) and the Foreign Housing Exclusion (FHE). There are ways around this limitation such as excluding only part of your income or claiming the Foreign Tax Credit instead.
2. Take advantage of the potential tax benefits.
There are 2 types of IRAs, the Traditional and the Roth, and they each have distinct tax advantages and eligibility rules.
- Earnings on the investments in your Traditional IRA can grow tax-deferred. Taxes are then paid when withdrawals are taken from the account—typically in retirement. Starting at age 72, required minimum withdrawals become mandatory, and these are taxable (except any nondeductible contributions).
- Contributions to a traditional IRA may be tax-deductible for the year the contribution is made in certain rare situations. Most often, if you live outside the US, you are more likely to take advantage of nondeductible IRA contributions. Please also note that your income does not affect how much you can contribute to a traditional IRA—you can always contribute up to the annual limit as long as you have enough earned income to cover the contribution*.
- Earnings can grow tax-free, and, in retirement, qualified withdrawals from a Roth IRA are also tax-free. It is important to note, however, that if you live outside of the US there is a risk that your country of residence may not recognize the tax-free status of your Roth IRA (double taxation agreements between the US and your country of residence will dictate the treatment of Roth IRA distributions).
- Contributions made to a Roth IRA are after-tax, so there are no tax deductions allowed on your income taxes. Please note that contributions to a Roth IRA are subject to income limits. If your income is too high to contribute, you may be able to advantage of a Backdoor Roth IRA. Plus, there are no mandatory withdrawals during the lifetime of the original owner.
**Please note that IRA contributions for American expats should be considered on country by country and case by case basis. It is crucial to consider the local tax rules of the country where you live when making contributions as well as the local tax rules of the country where you plan to retire and eventually take distributions.
Which IRA contribution is best for you? Get in touch with us and we will help you make the right choice!
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