Explore Reducing Your 2021 Tax Bill with a Prior-Year Contribution to Your Self-Directed IRA
Published on April 7, 2022
Contributing to your self-directed IRA qualifies as a checkmark on your retirement savings strategy and provides tax advantages as well. If you overlooked making an IRA contribution for 2021 or didn’t max out your 2021 contributions, it’s not too late. Even though the tax filing deadline is right around the calendar corner on Monday, April 18, you may make a prior-year contribution to your self-directed IRA until the filing deadline and potentially reduce your 2021 taxable income (note that Roth contributions are not tax deductible).
TIP: To ensure the funds are applied to 2021 in time to file your tax return, speak to your tax advisor about the best date to submit your contribution.
How much can you contribute and/or deduct?
The annual contribution limit is $6,000 for both a Traditional and Roth IRA ($7,000 for taxpayers over age 50). Note, however, that Roth contributions may be further limited based on your modified adjusted gross income.
Contributions to a Traditional IRA are tax-deductible up to the limit and grow tax-deferred; the distributions are taxed when you take them. Contributions to a Roth IRA don’t change your adjusted gross income because that money is post-tax; you are taxed on contributions now, but the investment earnings and distributions are tax free.
Therefore, if you’d like to lower your taxable income for the previous tax year, there’s still time to do so by contributing to a Traditional IRA. However, you’ll need to determine which will provide you the greatest benefit on your tax return—current year or prior year. That should be discussed with a trusted tax or financial advisor.
Determining current, or prior-year, contribution
There’s no real right or wrong here; it all depends on your specific financial situation. Two factors to consider are how much you plan to contribute this tax year (2022) to your self-directed IRA, and what your taxable income is for last year and this year.
- Planning contribution amounts. For instance, if you already met last year’s contribution limit, you may only make current-year IRA contributions or would incur penalties for exceeding that limit. However, if you have room for more 2021 IRA funding and you plan to also meet this year’s contribution limits, you can make both prior-year and current-year contributions. For taxpayers who also have a workplace retirement plan (or their spouses have one and they file jointly), the IRS places certain restrictions regarding modified adjusted gross income and the amount they can deduct.
- See where you are in your tax bracket. Taxpayers on the lower end of their 2021 tax bracket may benefit from making a prior-year contribution to reduce their taxable income; this could also result in falling under a lower tax bracket. However, if 2022 is looking good financially in terms of income, you might want that tax break for current-year taxes instead. Your tax or financial advisor can help you determine the strategy that’ best for you
How to make a prior-year contribution to your self-directed IRA
You may make a prior-year contribution and apply it to 2021 without issue if you have not yet filed your tax return. However, if you already submitted your 2021 return and want to make a prior-year IRA contribution, you must file an amended tax return.
Check your statements or contact your IRA administrator to ascertain your 2021 contribution amount to add funds to your self-directed IRA according to IRS regulations.
When you deposit the funds, be sure to tell your self-directed IRA administrator (and note it somewhere) to apply the contribution to 2021; otherwise, it will likely default to 2022 (and will show up on your tax return next year).
How Next Generation can help
At Next Generation, we offer client education about all things related to self-directed retirement plans. Our team is committed to making every transaction a smooth one, and handle each of our client accounts with utmost care, ensuring we maintain its tax-advantaged status. If you have questions about making a prior-year contribution to your existing IRA at Next Generation or would like to get one started, you may email us at NewAccounts@NextGenerationTrust.com, call (888) 857-8058 or text us at (848) 233-4076. If you need insights into how self-direction as a retirement strategy can work for you, we offer a complimentary education session to help you sort it out.