Leveraging large tax credits to improve your retirement can be a great idea. If solar makes sense for your home, then now is a good time to do it.
Back in 2015, Congress extended the solar panel tax credit – also called the investment tax credit (ITC) for five more years. This credit makes solar energy more affordable for all Americans.
That means that you can deduct 26 percent of the cost of solar power installation from your federal taxes if you installed between 2016 and 2019 in 2020.
The tax credit will dip again in 2021.
In 2021, you’ll get a 22% deduction. And in 2022 or later, only owners of new commercial solar system installation will receive a 10% deduction.
How to Use the Solar Panel Tax Credit
Not only is it good for the planet, but using the tax credit to go solar has other benefits, too.
First, there is no cap on how much your credit is worth. It’s just 30% of whatever the installation cost was.
Second, you’ll be able to use that tax credit to decrease your tax bill for the year.
And third, this deduction makes it easier for homeowners (and business owners) to switch to solar power, which saves on energy.
Why You Might Be Expecting a Large Refund
If you used the solar panel tax credit, you might be getting back more money than you expected in your refund. You might have also withheld more than you needed to throughout the year.
If it was a withholding issue, remember that a large refund isn’t the goal. It’s nice to have a big sum of money come in all at once, but that money can usually be put to better use if you are receiving it in your paychecks throughout the year.
Check your withholdings to make sure your refund isn’t as large next year.
What to do with a Large Refund? Try Converting IRA Money to a Roth
Many people treat a large tax refund as “fun money,” something they can use to pay for a vacation or home upgrades. That’s fine if you can afford it and have planned to use it in that way, but there are other ways to really put that money to good use.
One option is to convert IRA money to a Roth instead of taking a large refund. This is called a Roth conversion. If you complete your conversion before Dec. 31st, your refund will be reduced.
The steps for a Roth conversion include:
- Place tax-deferred, deductible money in your traditional IRAs
- Make your non-deductible contribution
- Put the money in a cash fund or money market account to avoid being taxed on it
- Wait about a month to receive a statement from the IRA provider
- Convert the funds from the traditional IRA to the Roth IRA
- Report the conversion on your taxes with Form 8606
- Repeat the process annually to get the most benefit out of your Roth conversion
You can read about the process more in-depth in this blog post.
In addition to giving your refund money a better purpose, Roth conversions have some very attractive tax benefits.
First, Roth IRA withdrawals are tax-free in retirement, as long as you meet the requirements. Traditional IRAs require you to pay taxes on money earned.
Roth IRAs also don’t have required minimum distributions (RMDs) during your lifetime, while traditional IRAs require you to start taking RMDs at age 70 ½.
Do you need help getting your finances organized? Contact me today to set up a meeting to talk about your goals. You can also download my free ebook for physicians for tips and information about getting your finances on track.