Not only is saving for retirement a great investment in your futures, it can also help save you some money at tax time. There are several different ways that retirement savings can have a positive impact on your tax refund, however, remember that penalties do exist for early or late withdrawals. Depending on the type of retirement account you have, you can use the following advice to maximize your tax benefit.
401(K): Deferring paying the income tax on contributions can save you immediately. You are able to defer the tax on up to $18,000 of contributions to a 401(k), 403(b), or the Thrift Savings Plan. You won’t be required to pay the tax on the money until you withdraw it.
IRA: Like a 401(k), you can defer the tax up to $5,500 of contributions made to a traditional IRA. Since the contributions are required until April 15, it’s a good idea to make a contribution right before filing your taxes. This will help reduce your tax bill, and possibly even boost your refund.
Roth IRA: The contribution limitations are the same as a traditional IRA, though they are made after the money has already been taxed. This means that any money withdrawn during retirement is tax-free.
Roth 401(k): There’s no immediate tax benefit for contributions made to these types of retirement savings, although you refrain from paying taxes on withdrawals on accounts that you’ve held for longer than five years. Also, your saving grow without you having to worry about taxes on the contributions.
Some additional ways to save at tax time on your retirement accounts:
Employees over the age of 50 can add an additional $6,000 to their 401(k) and IRA savings, which can boost their retirement fund. Traditional IRA contributions end at age 70 ½ though, so prepare accordingly.
Another practice is to avoid penalties for early withdrawals made from retirement funds. Early withdrawals usually occur when a taxpayer takes money before the age of 59 ½ and are taxed at 10%. There are exceptions to the penalty for IRA withdrawals if they are used for things like college, first home purchases, health insurance, or medical bills.
Typically, you are required to take withdrawals from your 401(k) and traditional IRA accounts after the age of 70 ½. You should seek to take the required minimum distribution, or you could face a hefty 50% tax on the amount that you should have received. However, you are eligible to delay withdrawals from a 401(k) if you are still working at age 70 ½ and you aren’t in ownership of more than 5% of the company. This only applies to the current 401(k), and not IRAs or retirement funds from previous jobs.
The Saver’s Credit
The Saver’s Credit is a tax benefit offered in addition to tax deductions for single filing employees with AGI below $30,500 ($45,750 and $61,000 for head of household and married filers, respectively). The tax credit can net you a benefit anywhere between 10% and 50% of your IRA or 401(k) savings, with a maximum of $2,000 for individuals, and $4,000 for couples. The lower your income, the bigger the credit.
