Even though 2021 is almost over, you have time to implement a few retirement planning tax strategies that can impact your potential income tax liability due on April 15. These strategies can help you now and set you up for a successful 2022. This article is short, sweet, and to the point—even though you have time to make some of these moves, you’ll want to discuss them with your tax professional to make sure they are appropriate for your personal situation.
6 Retirement Planning Tax Strategies You Need to Know
1. Max out your IRA contributions.
Contributing the maximum amount allowed to your traditional IRA or Roth IRA every year is a great retirement planning tax strategy and offers additional benefits. All contributions into your IRA reduce your taxable income and reduce your income tax burden at the end of the year. Your annual IRA contributions also help build income in the account to reinvest, you’ll earn tax-sheltered income on any gains, and compound interest on your investment gains works over time to grow additional income in your IRA.
If you did not contribute the maximum allowed into your IRA last year, you still have time to make a contribution to count for 2021. Traditional and Roth IRAs allow contributions in 2022, until April 15 that can be earmarked as a 2021 contribution. The annual contribution limit for both plans is the same: $6,000 per year with a catch-up contribution of $1,000 if you’re 50 years or older.
The same goes for your 401(k). Whether you have a 401(k) with your employer or a self-directed solo 401(k), max out your contributions every year to build retirement wealth.
2. Open and fund an IRA.
If you don’t have an existing IRA, you have time to open one and make contributions to reduce your tax liability. You have until April 15, 2022, to open and make contributions to a Roth or traditional IRA to count for 2021. However, you must make sure you designate the contribution is for 2021. Your tax and/or financial professional can help ensure you do this correctly.
3. Make sure your IRA contributions do not exceed the annual limit.
It is possible to contribute more to your IRA than the IRS allows. Thankfully, provided you catch this error before you file your taxes and remove any excess contributions from the account, you can avoid the 6 percent penalty levied on excess contributions. If you don’t make corrections before you file your taxes, you’ll owe that penalty every year until you correct the oversight. You have until your tax filing date, plus extensions, to remove the excess amount contributed. So, if you exceeded your IRA contributions in 2021, you have until April 15, 2022 or October 15, 2022 (the extension deadline) to remove that excess amount.
4. Open a self-directed IRA and invest in alternative assets.
Self-directed IRAs offer a unique retirement planning tax strategy that can help you in several different ways.
- You can use alternative investments instead of stocks bonds to build income.
- Account owners choose assets they personally know and understand.
- Income in the account grows tax-free (Roth IRA) or tax-deferred (traditional IRA).
Pro tip: You can also open a self-directed solo 401(k) to maximize retirement plan savings if you own a small business or are self-employed.
Two examples of how self-directed accounts can help you minimalize tax liability now and in retirement:
If you buy and sell real estate investments in your IRA, income—including capital gains from the investment property sales—is deposited directly into your IRA. If you use a Roth, that income grows tax-free in your account, and you won’t owe taxes when you take distributions in retirement. If you use a traditional IRA, the income grows tax-deferred, but you’ll pay tax on it when withdraw it in retirement.
If you trade bitcoin and other cryptocurrency in your IRA, it works the same as real estate. This is a big benefit when it comes to investing in crypto. For instance, if you personally invest in Bitcoin or other crypto, you must report all gains on your tax return. You are also required to report goods or services you purchase with cryptocurrency. Maintaining proper records for tax-reporting can be extremely time consuming. But, if you invest in crypto with your self-directed Roth or traditional IRA, your gains enjoy the same tax-sheltered status stated in the above real estate section.
Bitcoin and real estate are not the only assets you can invest in using a self-directed IRA. There is an incredibly large pool of alternative investments permissible in these accounts that allow you to invest out of the Wall Street box to earn retirement income.
5. Learn the benefits of a checkbook IRA.
A checkbook IRA, also known as an IRA LLC, is a powerful retirement savings account that gives you checkbook control over your retirement funds. This means account owners can write checks on the spot to purchase assets. In today’s hot market, individuals who invest in real estate appreciate the ability to invest quickly, ahead of the competition. Additionally, account owners can write checks directly from IRA funds to pay bills associated with their assets. For example, multifamily property investors typically have frequent expenses to maintain large properties with multiple units. Checkbook IRAs allow them to pay for these expenses without having to submit the bill to their IRA administrator first. If you like this type of freedom and control, then this type of self-directed account structure is a perfect fit for y
6. Open a health savings account.
Health savings accounts (HSAs) are fantastic tools that can generate income to help you pay medical expenses today as well as when you retire. Your contributions to the account are tax deductible, which does help you further reduce your annual income tax liability. Plus, because account balances rollover year after year, you could end up with quite a tidy next egg when you retire. HSA funds keep you from dipping into your actual retirement income when unexpected and potentially costly health issues arise.
Once you turn 65, you can withdraw funds from your HSA to use for anything—not just medical costs. You will have to pay tax on those withdrawals, but there won’t be a penalty for using those funds for non-medical purposes. This ability has the potential to greatly supplement your retirement income so that you can truly enjoy your golden years.
Pro tip: You can also self-direct an HSA.
Self-directed HSAs work the same way self-directed IRAs work, allowing you to choose and use alternative assets to build wealth in the account.
The above are just a few retirement planning tax strategies you can use to your benefit to help reach your investing, retirement, and tax planning goals. Always consult with your tax professional for help navigating tax rules and strategies that apply to you.
If you have questions about alternative investments and the advantages of self-directed retirement and other savings plans, please contact Advanta IRA today.
This article was first published on February 26, 2021, and has been updated with current information.