Retirement Planning When Filing Separately

When it comes to financial planning, one of the most important areas to consider is your retirement savings strategy. For married couples, the choice of how to file taxes—either jointly or separately—can have significant implications on their ability to save for retirement. While the majority of married couples choose to file jointly because it generally offers more favorable tax benefits, there are specific situations where filing separately (known as Married Filing Separately, or MFS) may be the better option.

This decision, however, comes with its own set of challenges and trade-offs, particularly when it comes to contributing to retirement accounts and taking advantage of valuable tax benefits. In this comprehensive guide, we will explore the key considerations and strategies for married couples who decide to file separately, providing actionable advice to help you navigate the complexities and make the most of your retirement savings opportunities.

Whether you’re just starting out on your retirement planning journey or looking to optimize your existing strategy, this article will equip you with the insights you need to make informed decisions and secure a comfortable financial future.

Married Filing Jointly vs. Married Filing Separately: A Closer Look

Before delving into retirement planning strategies, it’s essential to understand the key differences between filing taxes jointly and separately. While married filing jointly is typically the default filing status for most couples due to its potential tax advantages, filing separately can sometimes make more sense based on your unique financial situation.

Married Filing Jointly (MFJ)

• Tax Benefits: Filing jointly generally allows couples to access a wider range of tax benefits, such as higher income thresholds for tax brackets and eligibility for tax credits like the Child Tax Credit and Earned Income Tax Credit.
• Retirement Contributions: Joint filers have the ability to contribute the maximum amount to retirement accounts like Traditional IRAs and Roth IRAs and may be eligible for certain employer-sponsored 401(k) matching programs, which can significantly boost retirement savings.

Married Filing Separately (MFS)

While MFS may limit access to some of the above benefits, there are scenarios in which this filing status could be advantageous, such as:

• Separation of Financial Responsibility: In cases of separation or if one spouse has significant medical expenses or other financial issues, MFS allows each spouse to report their income and deductions separately. This can be beneficial if one spouse is eligible for deductions that would be limited under a joint return.
• Protection from Liability: Filing separately can protect one spouse from being held liable for the other spouse’s tax debts, which can be critical in cases where there is a significant financial disparity or disagreements regarding tax filings.

Understanding the Implications of Married Filing Separately

Before we delve into specific retirement planning strategies, it’s essential to grasp the potential implications of choosing the married filing separately tax status. When you file separately, you and your spouse each submit your own individual tax return, claiming only your own income, deductions, and credits. You’re each responsible for your own tax liability.

Couples might opt for MFS for a variety of reasons:

• Significant disparity in incomes
• One spouse has substantial itemized deductions
• Desire to keep finances separate
• Concerns about joint liability
• Income-based student loan repayment or other income-driven benefits
• Qualifying for certain deductions or credits

However, the MFS status comes with some notable drawbacks:

• Many tax credits and deductions are reduced or eliminated
• Income thresholds for phaseouts are generally lower
• Alternative Minimum Tax (AMT) exemption is lower
• Both spouses must choose the same method (itemize or standard deduction)
• Cannot claim earned income tax credit, education tax credits, or child and dependent care credit

Most significantly for our purposes, MFS can impact your eligibility to contribute to certain retirement accounts and may reduce your contribution limits. It’s crucial to carefully weigh the pros and cons in your specific financial situation.

IRA Contribution Rules for Married Filing Separately

Individual Retirement Accounts (IRAs) are a popular tool for saving for retirement, offering tax advantages and flexibility. However, the rules for contributing to IRAs differ based on your filing status. Here’s what you need to know about traditional and Roth IRAs when you’re married filing separately.

Traditional IRA Contributions

With a traditional IRA, your contributions may be tax-deductible, and your earnings grow tax-deferred until withdrawal in retirement. If you’re married filing separately and lived with your spouse at any point during the tax year, your ability to deduct contributions depends on whether you or your spouse are covered by an employer-sponsored retirement plan.

If neither spouse is covered by an employer plan, you can deduct your full contribution, up to the annual limit ($7,000 for 2024; $8,000 if age 50+). If either spouse is covered, your deduction is limited if your modified adjusted gross income (MAGI) is $10,000 or more. If your MAGI is below $10,000, you can take a partial deduction.

Roth IRA Contributions

Roth IRAs are funded with after-tax dollars, offering the potential for tax-free growth and withdrawals in retirement. However, your ability to contribute to a Roth IRA is significantly restricted when you’re married filing separately.

If you lived with your spouse at any time during the tax year and your MAGI is $10,000 or more, you cannot contribute to a Roth IRA at all. If your MAGI is below $10,000, your contribution limit is reduced (and eventually phased out) in proportion to how far your income is above $0.

These limitations make Roth IRAs much less accessible for MFS couples compared to those filing jointly.

401(k) Plans and Married Filing Separately

If you’re employed and your company offers a 401(k) plan, good news – your ability to contribute is not impacted by your tax filing status. You can contribute up to the annual limit ($23,000 for 2024; $30,500 if age 50+), regardless of whether you file jointly or separately. Employer matching contributions are also unaffected by MFS status.

The main caveat here applies if you’re self-employed and have a solo 401(k). If your spouse earns income from your business, your MFS status may limit your profit-sharing contributions. As always in these scenarios, consult with a knowledgeable tax professional for guidance.

Maximizing Retirement Savings When Married Filing Separately

Despite the limitations imposed by MFS status, there are still several strategies you can employ to boost your retirement savings:

1. Prioritize 401(k)s: If you have access to an employer-sponsored 401(k), aim to contribute as much as possible, especially if your company offers a match. With high contribution limits, 401(k)s can be a powerful savings vehicle.
2. Consider a Spousal IRA: If you’re married and one spouse has little or no earned income, the working spouse can fund a Spousal IRA on their behalf. While still subject to the MFS contribution limits discussed above, this allows non-working spouses to save for retirement.
3. Explore a Backdoor Roth IRA: For high-income earners whose MAGI is above the Roth contribution limits, a “backdoor” Roth conversion might be an option. This involves making a nondeductible contribution to a traditional IRA, then converting it to a Roth. There are specific rules and potential tax consequences, so consult a professional.
4. Utilize Health Savings Accounts (HSAs): For eligible individuals with high-deductible health plans, HSAs offer a triple tax benefit – deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. Funds can be invested and carried into retirement, making HSAs a valuable supplement to your retirement savings strategy.
5. Take advantage of catch-up contributions: If you’re age 50 or older, you can make additional “catch-up” contributions to retirement accounts like 401(k)s and IRAs. In 2024, that’s an extra $7,500 for 401(k)s and $1,000 for IRAs.
6. Look into deferred compensation plans: Some employers offer non-qualified deferred compensation plans that allow you to set aside a portion of your income to be paid out in retirement. These plans have different rules and risks than 401(k)s, so carefully evaluate your options.
7. Don’t forget taxable accounts: While not as tax-advantaged as dedicated retirement accounts, taxable brokerage accounts can still be an effective long-term savings tool, especially if you’ve maxed out your other options. Just be mindful of tax implications.

The Power of Consistent Savings

Regardless of your filing status or the specific accounts you use, one of the most potent factors in successful retirement planning is consistent savings over time. Even if MFS status limits some of your options, regularly setting aside money and allowing compound growth to work in your favor can make a tremendous difference over a career.

Consider setting up automatic contributions from each paycheck to your retirement accounts, so saving becomes a habit. Aim to save at least 10-15% of your income for retirement, more if possible. And whenever you get a raise or windfall, consider boosting your contribution percentage.

While navigating the complexities of retirement planning as a married couple filing separately can feel overwhelming, remember that you don’t have to go it alone. Consult with a qualified financial advisor who can offer personalized guidance based on your unique circumstances, helping you optimize your strategy and stay on track.

A Final Word

Married couples who choose to file their taxes separately face unique challenges when it comes to retirement planning, but with the right strategies and a commitment to consistent saving, a secure retirement is absolutely within reach. By understanding the rules, leveraging the accounts and options available to you, and working with a trusted financial professional, you and your spouse can devise a plan to maximize your savings while minimizing your tax liability.

The key is to start early, save consistently, and stay engaged with your financial plan over time. With diligence and smart planning, you can overcome the hurdles of MFS status and build a comfortable nest egg to support the retirement of your dreams.

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From evaluating contribution limits to identifying tax-saving opportunities, the experts at Corvee and their industry-leading tools are here to help you make sense of it all. Schedule a free consultation today to learn how Corvee can help you and your clients achieve your retirement savings goals while minimizing tax liability. Together, we’ll chart a course to financial security and a fulfilling retirement. Get a free demo of Corvee’s tax planning software.