TaxWatch: One unexpected way to spend your stimulus check: you can shrink your 2020 tax bill with it

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Maybe you’re on firm financial footing and don’t need the third-round $ 1,400 stimulus check to make ends meet.

But maybe you don’t want to sink the money into bitcoin, meme stocks or a summer vacation.

With the distribution of economic impact payments coinciding with tax season, experts say it’s possible to use your stimulus money to simultaneously shrink your 2020 tax bill, increase your tax refund and save money for the future.

Another piece of good news: taxpayers have extra time to consider the money maneuver, which involves individual retirement accounts (IRAs) and health savings accounts (HSAs).

After the Internal Revenue Service pushed the 2020 income tax filing deadline to May 17, it announced Monday that May 17 also marks the end date to contribute money in the 2020 tax season to IRAs and HSAs.

In the right circumstances, stimulus check-funded contributions to these accounts can shave hundreds of dollars off a federal income-tax bill, according to calculations from Wendi Hall, managing partner at Small Office Solutions, a tax, accounting and financial advisory firm based in Brookfield, Wis.

She’s discussed ways to put the stimulus check money to use in the tax-advantaged accounts with some of her clients, she noted.

Hall and others emphasize that people should not be contemplating tax strategies if they have more pressing needs like bills to cover, debts to pay down or no built-up savings.

Chasing after a maximum tax refund at the expense of meeting necessities first should not be the goal, said Nadine Burns, CEO of A New Path Financial in Ann Arbor, Mich. “If you don’t have the basics done, you can’t go further.”

Indeed, many Americans are still strapped for cash. More than half of consumers said they were living “paycheck to paycheck,” according a March survey. Americans also had $ 1.56 trillion in student loan debt, $ 1.37 trillion in auto loan debt and more than $ 800 billion in credit card balances, according to fourth quarter data from the Federal Reserve Bank of New York.

“Getting yourself out of debt allows you to save for retirement sooner and longer if you’re not doing debt service year after year after year,” Hall said.

It’s tough to say how many people are earmarking their stimulus check money for investable retirement accounts.

But data shows more money has been pouring into IRAs during the past year. The average fourth quarter 2020 balance on IRAs through Fidelity Investments was $ 128,100. That’s a 9% jump from the third quarter and an 11% jump from the same point in 2019.

IRA account balances at Charles Schwab Corporation have also jumped, according to the firm, with the average balance on all types of IRAs rising to $ 93,287 in January 2021, up from $ 80,257 in April 2020.

How stimulus checks mix with IRAs and HSAs

Before the IRS started cutting the $ 1,400-per-person stimulus checks, some people who just missed the income eligibility cut-off ($ 80,000 for individuals and $ 160,000 for married couples filing jointly) were eyeing IRA and HSA contributions as a way to get under the adjusted gross income caps.

The same thinking can apply in reverse: With stimulus checks in hand — which are not taxable income — a person can reduce their adjusted gross income.

But the rules on both types of accounts are not blank checks for easy write-offs. People up to age 50 can contribute $ 6,000 annually to an IRA and people age 50 and above can contribute $ 7,000.

There is a dollar-for-dollar deduction which phases out depending on how much a household makes and whether the people in that household have access to a retirement plan at work.

Individuals who have access to a retirement plan at work can take the full deduction on IRA contributions if they have modified adjusted gross incomes of $ 65,000 or less, IRS rules say.

The partial deduction ends at $ 75,000. When both people in a married couple have a retirement plan through work, the full deduction applies for modified adjusted gross incomes up to $ 104,000.

If a single filer does not have access to a retirement plan, they can take the full deduction no matter what they make, the IRS says. The same goes when both people in a married couple do not have a retirement plan through work. If one member of the married couple has access, the full deduction applies to households with modified adjusted gross incomes of up to $ 196,000.

HSAs are paired with high-deductible health plans where deductibles cost at least $ 1,400 for an individual and $ 2,800 for a family. There’s a $ 3,550 individual contribution limit and a $ 7,100 contribution limit on family coverage. For HSAs, there’s no deduction phase-out pegged to income, Hall noted.

HSAs are meant for medical expenses, but a 20% additional tax on distributions for non-medical expenses goes away when account holders turn 65. The IRS can levy a 10% penalty on IRA withdrawals before age 59 ½. (The CARES Act put those rules on pause, but taking cash out early could still be complicated.)

For Burns, the full combination of account uses and tax rules makes her a big believer in HSAs. “HSA trumps them all, if you can do it,” she said.

Either way, how can those account rules mix with stimulus check money?

Here are some examples:

• Single filers with $ 90,000 in taxable income (after taking a standard deduction or itemized deduction) and no retirement plan through work would cut their federal tax bill by $ 308 dollars if they put the complete $ 1,400 check in their IRA or their HSA, Hall determined. “If you’re already getting a refund, you’re getting $ 308 more. If you already owed, you’re paying $ 308 less,” she explained.

• Suppose there’s a married couple with two kids. One has a retirement plan through work and the other doesn’t. With a $ 90,000 taxable income and a $ 5,600 stimulus check for four people, Hall said they could save $ 1,232 on their tax bill by putting that money in an IRA or HSA.

“For someone who is not in debt, someone who does not have an employer plan at work, this is a good way to seed a new IRA and get that habit started,” Hall said.

When she’s discussed the possibility of putting clients’ stimulus check money in accounts, she says they have to consider how much they have already contributed to both accounts and whether they are in the phase-out range on the IRA deductions.

Though the influx of stimulus check money adds a new spin to the talk on slimming the tax bill, Hall said, “it’s a conversation every year.”

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