We are close to the end of the tax year. Taxpayers have until December 31 to take steps to fund or establish their retirement plan to save in taxes. There are four things to consider.

1. Establish Your 2021 Retirement Plan

Do you or your company have a retirement plan in place? If not, and if you have some cash, you can contribute into a retirement plan to obtain a tax deduction for 2021.

For most defined contribution plans, such as 401(k) plans, you (the owner-employee) are both an employee and the employer, whether you operate as a corporation or as a proprietorship. And that’s good because you can make both the employer and the employee contributions, allowing you to contribute a good amount of money.

The total contributions for the year to all traditional IRAs and Roth IRAs cannot be more than: $6,000 ($7,000 if you’re age 50 or older). For single taxpayers, your Modified Adjusted Gross Income (MAGI) must be under under $140,000 for the tax year 2021 to contribute to a Roth IRA, and if you’re married and filing jointly, your MAGI must be under $208,000 for the tax year 2021. For 401(k) plans, taxpayers can contribute up to $19,500 in 2021 and $20,500 for 2022 ($26,000 in 2021 and $27,000 in 2022 for those age 50 or older).

2. Claim the New and Improved Retirement Plan Start-Up Tax Credit of Up to $15,000

By establishing a new qualified retirement plan (such as a profit-sharing plan, 401(k) plan, or defined benefit pension plan), a SIMPLE IRA plan, or a SEP, you can qualify for a non-refundable tax credit that is the greater of

  • $500 or
  • the lesser of (a) $250 multiplied by the number of your non-highly compensated employees who are eligible to participate in the plan, or (b) $5,000.

The credit is based on your “qualified start-up costs,” which means any ordinary and necessary expenses of an eligible employer that are paid or incurred in connection with

  • the establishment or administration of an eligible employer plan, or
  • the retirement-related education of employees with respect to such plan.

3. Claim the New Automatic Enrollment $500 Tax Credit for Each of Three Years, a total of $1,500.

The SECURE Act added a non-refundable credit of $500 per year for up to three years, beginning with the first taxable year of 2020 or later in which you, as an eligible small employer, include an automatic contribution arrangement in a 401(k) or SIMPLE plan.

The new $500 auto-contribution tax credit is in addition to the start-up credit and can apply to both newly created and existing retirement plans. Further, you do not have to spend any money to trigger the credit. You simply need to add the auto-enrollment feature, which does contain a provision that allows employees to opt out.

4. Convert to a Roth IRA

Consider converting your 401(k) or traditional IRA to a Roth IRA.

If you make good money on your IRA investments and you will not need your IRA money during the next five years, the Roth IRA over its lifetime can produce financial results far superior to the traditional retirement plan.

You first need to answer this question: How much tax will you have to pay to convert your existing plan to a Roth IRA? With this answer, you now know how much cash you need on hand to pay the extra taxes caused by the conversion to a Roth IRA.
Here are four reasons you should consider converting your retirement plan to a Roth IRA:

  1. You can withdraw the monies you contribute into your Roth IRA at any time, both tax-free and penalty-free, because you invested previously taxed money into the Roth IRA account.
  2. You can withdraw the money you converted from the traditional plan to the Roth IRA at any time, tax-free. However, if you make that conversion withdrawal within five years of the conversion, you pay a 10 percent penalty. Each conversion has its own five-year period.
  3. When you have your money in a Roth IRA, you pay no tax on qualified withdrawals, the earnings, which are distributions taken after age 59 1/2, provided you have had your Roth IRA open for at least five years.
  4. Unlike with the traditional IRA, you do not have to receive required minimum distributions from a Roth IRA when you reach age 72, to put this another way, you can keep your Roth IRA intact and earning money until you die. 

Do you know that you could reduce your tax liability by proper tax planning strategy as individual or business owner?

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