As tax season heats up it is important remember that there are certain things that can still be done to impact the 2020 tax return. An important example of this is the Traditional Individual Retirement Account (IRA).
For taxpayers who qualify the annual contribution limit for 2020 (assuming sufficient taxable compensation) is $6,000. For taxpayers 50 years of age and older it is $7,000. For those filing a joint U.S. resident tax return it is possible for both spouses to contribute, even if only one works. In the case of a U.S. citizen living and working abroad the “taxable compensation” requirement will require some special considerations.
Contributions are generally tax deductible. However, if the taxpayers are covered by other retirement plans (such as a 401K plan at work) and have income that exceeds certain IRS defined levels (starting at $65,000) the deduction is phased out. Once the threshold is exceeded there is no deduction in that year.
The deadline for opening and funding the account is April 15th. This date is important for two reasons. First, it allows taxpayers to take tax advantage of a contribution by opening an account after the end of the year (2020). Second, it also provides a vehicle and opportunity to make the current years contributions as well (for 2021).
For 2020 and later, there is no longer an age limit on making regular contributions to Traditional IRA’s.
Once funded the balance can grow on a tax deferred basis. At age 72 the taxpayer is required to start taking Required Minimum Distributions (RMD). RMD’s are generally taxable but the precise amount will depend on the extent of deductible contributions that were made.
For a foreign national no longing living in the U.S. there will be withholding taxes on the annual distributions. The withholding tax amounts may be modified by an income tax treaty, depending upon where the taxpayer is living when the RMDs begin. The treatment of any U.S. retirement account in a foreign country should be verified as early as possible, but certainly before the taxpayer terminates U.S. residency.
For those who are anticipating larger balances it will be important to consider the estate tax consequences of owning a U.S. IRA balance at the date of death. For a foreign national who no longer lives in the U.S. the account will be considered a U.S. situs asset, subject to U.S. estate tax to the extent the values exceed the exemption amount which is presently $60,000.
Additional planning opportunities may also exist by converting the Traditional IRA accounts into tax Free Roth IRA accounts (or just setting up Roth IRA accounts from the outset). These enhanced benefits require careful planning.