You’ve started working on your tax return (or spoken with your accountant) and it looks like you’ll owe more taxes than you’d like. Now what? It’s too late to change your 2016 taxes now that it’s 2017, right? Fortunately, retirement savings can save you and reduce tax liability!
If you didn’t max out your contribution to a traditional IRA during 2016, you have until April 15th (April 18th in 2017) to contribute to a traditional IRA and have it reduce your 2016 taxes. When you make an IRA contribution between January 1st and April 18th of 2017, you can designate the contribution as either a “current year” contribution (which would be reflected on your 2017 tax return) or as a “prior year” contribution (which would be reflected on your 2016 tax return). The maximum annual contribution to an IRA is $5,500 per year (or $6,500 if 50 or older), but contributions cannot be made to a traditional IRA if you are 70.5 years or older.
There are some additional restrictions relating to whether your contributions to a traditional IRA are deductible. If you (and your spouse, if you are married) have a retirement plan through work, you can fully deduct the amount of your IRA contribution if your modified adjusted gross income (MAGI) is below $61,000 ($98,000 for married filing jointly/$10,000 for married filing separately). If your MAGI is above that threshold, but below $71,000 ($118,000 for married filing jointly), you can take a partial deduction of your IRA contribution. If you are married filing separately, no deduction is available if your MAGI exceeds $10,000.
If you are not covered by a retirement plan at work (and your spouse, if you’re married, is not covered by a plan at work), then there is no income limitation and your traditional IRA contribution is fully deductible up to the amount of the annual contribution limit. If you’re not covered by a retirement plan at work, but your spouse is, you can still take a full deduction if your MAGI is below $184,000 and you file jointly (married filing separately is still subject to the $10,000 MAGI limit).
If you’re self-employed, you have even more flexibility to reduce your taxable income through retirement savings. A Simplified Employee Pension (SEP) IRA allows you to contribute up to the lesser of $53,000 (for the 2016 tax year) or 25% of your net earnings from self-employment (excluding any SEP contributions to yourself). Even if you don’t have a SEP plan in place, the IRS allows you to establish a plan up to the extended due date of the tax return! This means that you have until October 17th (if you extend your Form 1040) to establish and contribute to a SEP.
As their name suggests, Simplified Employee Pension plans are very simple to set up. You prepare Form 5305-SEP to establish the SEP IRA plan and file it away for your records– you don’t even need to send it to the IRS! SEP plans require the employer (you) to contribute the same percentage to all employees (up to the annual limit). If you are self-employed and have no employees, this is an easy decision, since you are the only one for whom contributions will be made. If you have employees, however, you’ll need to contribute the same percentage to their SEP IRA as you do to yours, so although you may want to max out your own contributions, you’ll need to match the percentage for your employee(s), up to 25% of their compensation. This can be a good planning opportunity if you employ a spouse – you can further reduce your taxable income by contributing to both your SEP IRA and theirs. There is flexibility from year-to-year, so if your business dips in the future, you can decide not to make any contributions.
Utilizing these retirement savings strategies is a double-win: you reduce your tax bill while you save money for retirement! If you’d like help setting up a SEP or other retirement plan, or would like to discuss tax savings for next year, please reach out to us for assistance.