With the expansion of available COVID-19 vaccines, many workers are looking forward to shutting down their home offices and soon heading back to their offices.
Others, however, have left the workforce for good.
Unfortunately, the work status change for some recent retirees didn't happen quite as they had planned.
More than two-thirds, or 68 percent, of individuals who responded to Allianz Life's 2021 Retirement Risk Readiness survey said they retired earlier than expected. That's a significant increase from the 50 percent who took early retirement last year.
The coronavirus pandemic has underscored that much of life is beyond our control. But that doesn't mean we should abandon our planning. In fact, the work and life challenges have underscored the need for more attention to our finances.
And when it comes to retirement, the tax code can help. Here's a look at three popular retirement plan and the various tax advantages the offer.
Traditional IRA: This retirement savings option starts the list because it's one that can provide you prior tax-year savings up until the filing deadline, which typically is April 15. (Yes, the mid-April deadline is still in effect for 2020 return filings, despite efforts by some in Congress and the tax pro community to push it a bit further into the year.)
UPDATE, March 18, 2021: The IRS officially changed the deadline to file and pay 2020 taxes to May 17.
This granddaddy of retirement vehicles lets you put in money before it's taxed. That shaves a bit off the final amount upon which you'll eventually owe taxes.
Your traditional IRA's earnings then grow tax-deferred. As noted earlier, those contributions can be made as late as April 15.
UPDATE, March 29, 2021: With some, but not all April 15, 2021, deadlines changed to May 17, some raised questions as to the 2021 date when taxpayers could make a retirement plan contribution and count it toward the 2020 tax year. The IRS answered that question today, announcing today that May 17 also is the deadline this year for individuals to make 2020 tax year contributions to their individual retirement arrangements, either traditional IRAs or Roth accounts. May 17 also is the deadline to contribute to and count as 2020 amounts to health savings accounts (HSAs), Archer Medical Savings Accounts (Archer MSAs) and Coverdell education savings accounts (Coverdell ESAs).
The amount you can put into a traditional IRA is adjusted for inflation. For 2020, the maximum contribution amount is $6,000. If you're age 50 or older, you can contribute another $1,000 for the tax year.
But the biggest plus for some traditional IRA owners is that in addition to help save for future retirement, account contributions can help reduce your tax obligation now. The contributions can be claimed as an above-the-line deduction.
The deduction (technically an adjustment to income found on Form 1040's Schedule 1) depends on your earnings and whether you (and your spouse, if you're married) have workplace retirement plans. Depending on your marital status and any job-offered retirement plan to you (and your spouse), the deductible amount of a traditional IRA contribution could be phased out or totally eliminated.
For 2020, the traditional IRA phase out trigger begins at $65,000 of modified adjusted gross income (MAGI) for single taxpayers with a workplace plan or $104,000 for a married, jointly filing worker who has a retirement plan at work. You can read more on the myriad filing status, workplace plan situations and income phase out ranges for traditional IRAs in my most recent post on retirement plan inflation adjustments.
The biggest drawback to a traditional IRA is that it's a tax-deferred plan. That means you'll eventually owe tax on your contributions and earnings, usually when you withdraw money in your retirement. You can put off those withdrawals and associated taxes by delaying withdrawals, but the IRS won't wait forever. Once you turn 72, you must take out a certain amount, known as a required minimum distribution or RMD, each year.
Roth IRA: The Roth IRA, named after the late U.S. Sen. William Roth of Delaware who championed it when it was created in 1997, is a popular option. Its allure is that you contribute money that's already been taxed. That means you can't deduct what you put into the Roth IRA, but it also means that when you eventually take out the money when you retire, you won't any tax on the distributions.
In fact, since you already paid tax on your contributions, you can withdraw them at any time without tax penalty. When you turn 59½ — you do celebrate half-birthdays, right? — you can withdraw both contributions and earnings without triggering any tax trouble as long as you've had the Roth IRA for at least five tax years.
The maximum annual contribution amount to a Roth IRA is the same as a traditional IRA. That's $6,000 in 2020, along with the $1,000 catch-up contribution if you're age 50 or older. And you also have until April 15 to put the money in the Roth and have it count toward the prior tax year.
The one drawback for a Roth IRA is that your contribution amount could be phased out or eliminated if you make more than a certain amount. For 2020, the trigger for reducing Roth contributions is MAGI of $124,000 if you're single or $196,000 for married jointly filing couples.
Again, my most recent post on retirement plan inflation adjustments has more on Roth IRAs and earnings levels that limit them.
401(k) Plan: These employer-sponsored defined contribution retirement plans essentially have replaced old-fashioned defined benefit pension plans. You open or opt into a 401(k) at your job and then have regular paycheck contributions go into the plan. Ideally, your employer also will contribute to your 401(k), with a match of up to 3 percent of the worker's contributions the standard.
The paycheck contributions are pre-tax for a traditional 401(k) plan. That means, like a traditional IRA, the 401(k) money eventually is taxed.
Some companies also offer Roth 401(k)s, which like the IRA are funded by after-tax worker dollars. Again, like their Roth IRA counterparts, the workplace plans' distributions are tax-free.
The amount you can put into your 401(k), Roth or regular, is adjusted annually for inflation. For the 2020 tax year, the contribution limit was $19,500. Workers age 50 or older could have contributed another $6,500 to their 401(k) plans.
You can't do anything about last year's workplace plan contributions now. You can, however, make sure you open and contribute as much as you can afford — at least enough to get your employer's matching amount — to a 401(k). For 2021, the contributions limits are the same as in 2020.
Also, your workplace retirement plan might have a different numeric name, which is taken from the tax code section under which it was created. If you have a 403(b), a 457 plan (in most cases) or participate in the federal government's Thrift Savings Plan, the same contribution amounts apply.
If you can afford to put away any money for your retirement, do so. The day you leave the cubicle farm for good will get here sooner than you realize. If you've planned for it and taken advantage of Uncle Sam's tax help for your golden years, you'll also be able to better deal with a surprise earlier retirement.
You also might find these items of interest:
- Rethinking retirement as traditional 3-legged stool wobbles
- 5 things to know about workplace retirement plan hardship withdrawals
- Use Form 8915-E to report, repay COVID-related retirement account distributions