Some tax advisors recommend delaying contributions to health savings accounts (HSAs), retirement plans, and IRAs until the end of the year. This is because you’ll receive the same tax deduction no matter what time of the year you contribute. But this is a huge mistake! Funding contributions early allows you to invest the funds to maximize your tax-favored earnings during the year.
Here are six ways to take advantage of increased tax-deductible contributions in 2020.
Fund increased HSA contributions
If you’re covered by a qualifying high-deductible health plan (HDHP) as we recommend, you’re eligible for tax-deductible HSA contributions. So, go ahead and fund the maximum 2020 contribution now—which has been increased to $3,500 for single and $7,000 for family—from your existing cash. Be sure to throw in an extra $1,000 contribution for each spouse age 55 or older. Don’t let those funds sit idle in a no-interest, high-fee checking account. Rather, you could add up to $560,000 in extra earnings by investing your HSA funds, which can be withdrawn tax-free later to the extent of your qualified medical expenses. (Read “Add up to $560,000 to your Health Savings Account (HSA) balance!” in the May 2017 issue of The McGill Advisory.)
Fund increased 401(k) salary deferrals
The maximum tax-deductible 401(k) salary deferral has been increased to $19,000 this year and $25,000 for those age 50 or older. So, go ahead and divide the maximum contribution amount by the number of expected pay periods for 2020 (12 if monthly, 24 if semimonthly, and 26 if paid every two weeks), and start deducting those increased salary deferrals beginning with your first 2020 paycheck.
Are you married? If so, make sure your spouse is employed, either through your practice or otherwise, so that he or she can also make the maximum tax-deductible salary deferrals to a 401(k) plan, which will double your family’s tax-deductible benefit.
Fund increased IRA contributions
Does your income exceed $137,000 (single) or $203,000 (married)? If so, you are not eligible to contribute directly into a Roth IRA. However, as long as you have earned income, you can still fund regular nondeductible IRA contributions, which have been increased up to $6,000 per spouse or $7,000 for each spouse age 50 or older. So, contribute now from your existing cash in order to maximize the earnings, which grow tax-deferred and are also protected from the 3.8% Affordable Care Act tax.
Convert regular IRAs into Roth IRAs
What’s better than tax-deferred IRA earnings? It’s tax-free earnings available only through a Roth IRA! While your income may be too high to contribute directly to a Roth IRA as discussed here, you can still legally convert your regular IRA contribution into a Roth IRA at any time to enjoy future tax-free growth. To avoid taxes on your Roth IRA conversion, make sure your investment advisor has rolled all of your taxable IRA funds into your 401(k) or other retirement plan first. If your advisor hasn’t done this or does not know how, you need to find an advisor who can.
Optimize your salary to maximize retirement plan efficiency
Retirement plan contributions for the benefit of doctor and staff are based on salary levels, so it’s important to set your salary at its optimal level. The maximum salary for retirement plan contributions is $280,000 this year. There’s no tax benefit in taking a higher salary since it only leads to increased income and payroll taxes, and it decreases the potential practice profits eligible for the new 20% deduction under Section 199A. Taking a salary below $280,000 could boost your Section 199A deduction, but any tax savings may be offset by retirement plan contributions that are lower for you and higher for the staff. So, make sure your tax advisor calculates the optimal salary you should take for the best economic advantage.
Increase automatic draft for practice retirement plan contributions
The 90% of our clients who save by automatic draft have accumulated more than twice as much as the 10% who do not. Why? Saving by automatic draft ensures that your saving happens. Also, it increases your potential investment return through dollar-cost averaging. Through investing the same amount each month, you buy more shares when the market drops and fewer shares when the market rises, providing a lower cost basis. This also helps avoid disastrous losses from emotional investing, which entices many doctors to buy when they feel ready, usually when the market is at an all-time high, and sell out of fear when it drops. So, estimate your practice-related contributions required so that you can receive the maximum retirement plan contribution for 2019—which has been increased to $56,000 if under age 50 and $61,000 if 50 or older for defined contribution plans—and break it down into monthly autodraft payments to ensure implementation.
JOHN K. McGILL, JD, MBA, CPA, provides tax and business planning for dentists and specialists. He publishes The McGill Advisory newsletter through John K. McGill & Company Inc., a member of The McGill & Hill Group LLC, your one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit mcgillhillgroup.com.
