We all dream of retirement – especially on days when the alarm goes off too early. But could your retirement account be helping you with your tax return now? Things have changed since last year. Here are some things to consider before you file your 2021 tax return.
Check Your Tax Credit Qualification
Depending on your adjusted income, you may qualify for a tax credit for making certain contributions to your IRA or employer-sponsored retirement plan. Read more about the Saver Credit eligibility to see if you could take a credit of up to $1,000.
Avoid Paying an Early Withdrawal Penalty
If you withdraw from your retirement accounts before age 59 ½, you are subject to income taxes plus an additional 10 percent early withdrawal tax. However, due to the COVID-19 pandemic, in 2020 there were many exceptions that waived this fee. Most of them have been reduced at this point, but you can still avoid paying an early withdrawal penalty if you are using the funds for post-secondary education or as a first-time homebuyer. Click here to learn more about exceptions to tax on early distributions.
Rollover Your Retirement after a Job Change
If the post-pandemic economy has you changing jobs, avoid income tax by transferring your 401(k) directly to another 401(k) or IRA. Without a direct transfer, 20 percent of the amount withdrawn will be withheld for income taxes and you could also owe the early withdrawal penalty.
Don’t Forget about Required Minimum Distributions
If you are age 72, your retirement account may feature required minimum distributions. This is an increase from the previous 70 ½ age requirement. While this was waived in 2020 due to COVID, that is not the case for 2021. The penalty for missing a required minimum distribution is 50 percent of the amount that should have been withdrawn – in addition to the income tax due. Consider directing your required minimum distribution to the charity or church of your choice to avoid tax liability.
Dodge Double Distributions
Avoid increased income taxes by ensuring you do not take two distributions in one year. You are required to take your first minimum distribution by April 1 of the year after you turn 72 (or 70 ½ if you were born before July 1, 1949). Following this distribution, subsequent withdrawals must be taken by December 31 each year. This could mean that you end up with two distributions in the same tax year if you wait until the April deadline, which could bump you into a higher tax bracket.
Similarly, by taking smaller distributions before age 62 can help spread your tax bill over multiple years, rather than dramatically increasing your taxable income once you turn 72. This would all depend on your other income at those ages.
If you have questions regarding how your retirement account could be influencing your income taxes, don’t hesitate to contact MBJ Accounting about setting up an appointment.