How to Use a Tax Refund to Fund an IRA Tax Deduction
The tax law offers a unique tax saver for some people on their 2021 tax returns: they can save for their retirement by contributing to an IRA and reduce their tax liability at the same time. Depending on their situation, IRA contributions may be fully or partially tax deductible.
In fact, if you do it early, they might be able to fund their IRA for the 2021 tax year with a refund that they can from their return!
Details: The maximum amount a taxpayer can contribute to an IRA for the 2021 tax year is $ 6,000 (or $ 7,000 if he is 50 years of age or older). (The IRS recently announced that these numbers remain the same for the 2022 tax year.) The total can be split among multiple IRAs.
Taxpayers have until the 2021 filing deadline – April 15, 2022 – to contribute. But the six-month automatic deposit extension until Oct. 17 does not grant any additional time for IRA contributions.
To begin with, contributions are deductible, but the deduction is phased out if the taxpayer (or their spouse, if married) actively participates in an employer-sponsored retirement plan such as a 401 (k) and their modified adjusted income (MAGI) exceeds a threshold.
The phase-out range for single filers who actively participate in the plan is between $ 66,000 and $ 76,000 for MAGI and between $ 105,000 and $ 125,000 for joint filers. If one of the spouses of a couple is an active participant, the elimination range is between $ 198,000 and $ 208,000 from MAGI. These dollar figures are also indexed annually for inflation. (The amounts have been increased for 2022.)
For example, a 45-year-old single filer who has a MAGI of $ 71,000 for 2021 and participates in an employer’s 401 (k) plan can deduct 50% of a $ 6,000 contribution, or $ 3,000. Note that IRA contributions are deducted “above the line” so that they reduce Adjusted Gross Income (AGI) for other tax purposes.
Contributions made to an IRA can be compounded without any current taxes. It is often a good addition to an employer sponsored pension plan.
Better yet, if a taxpayer is entitled to deductions for IRA contributions, they can take advantage of a unique tax strategy:
Idea in action: File your 2021 tax return early and claim a deduction for an IRA contribution you haven’t made yet. Then use the refund obtained to pay the contribution for the 2021 tax year. As long as the contribution is deposited no later than April 18e due date of the tax return, you are in the clear.
Can it really be done? Yes. The IRS gave its approval in a ruling decades ago. And he recently created form 8888, Direct deposit for reimbursement, which makes it easier for taxpayers to allocate part of a refund to a contribution. Follow the instructions on Form 8888.
What about Roth IRAs? The same contribution limits apply, but Roth contributions are never tax deductible. Additionally, the ability to contribute to a Roth is being phased out at certain MAGI levels, whether or not you are an active member of an employer plan.
Final words: Take advantage of the rules for your situation when filing for 2021.