Lower your tax bill.
Saving for retirement can qualify you for several different types of tax breaks. Some retirement accounts allow you to defer paying income tax on your retirement savings, while others help you avoid paying tax on any of the investment gains you accrue. Here’s how to lower your tax bill while building wealth for the future.
IRA
You can defer paying income tax on up to $5,500 that you deposit in an individual retirement account. A worker in the 25 percent tax bracket who maxes out this account will reduce his federal income tax bill by $1,375. Income tax won’t be due until the money is withdrawn from the account.
401(k) plan
These workplace retirement accounts allow employees to defer paying income tax on contributions of up to $18,000 in 2016. While few people are able to do it, a worker in the 25 percent tax bracket who contributed the maximum amount to a 401(k) would save $4,500 on his income tax return.
Roth IRA
Contributions to a Roth IRA won’t get you an immediate tax break. However, the investment earnings aren’t taxed while the money is in the account. And if you take withdrawals after age 59 1/2 from an account that is at least five years old, you won’t ever have to pay tax on the investment growth.
Roth 401(k)
These workplace Roth accounts also allow you to avoid paying tax on your investment earnings if you delay withdrawals until retirement. Roth 401(k)s have the same $18,000 contribution limit of traditional 401(k)s.
Catch-up contributions
Workers age 50 and older are eligible to defer taxes on an additional $6,000 in their 401(k) plans in 2016, for a total contribution of up to $24,000. They can also contribute up to $6,500 to an IRA, $1,000 more than younger savers.
IRA conversion
You can convert your traditional IRA balance to a Roth IRA if you pay income tax on the amount you convert. You might be able to reduce your lifetime tax bill if you complete the conversion in a year you have unusually low earnings. For example, if you expect to be in the 25 percent tax bracket in retirement, but pay a 15 percent tax rate on the converted amount, you will have decreased the tax due on your retirement savings.
MyRA
The myRA is a new type of Roth retirement account that is guaranteed never to lose value. The only investment option is a Treasury savings bond. Once you accumulate an account balance of $15,000 or the account turns 30 years old, the money is transferred to a private sector Roth IRA.
Tax refund
Part or all of your tax refund can be directly deposited into an IRA using IRS Form 8888. You can elect to use your refund to reduce next year’s tax bill or even your current tax bill if you meet the IRA contribution deadline.
Saver’s credit
In addition to the tax deduction on your retirement account contributions, low- and moderate-income workers can also claim the saver’s credit. This tax credit is worth between 10 and 50 percent of your retirement account contributions up to $2,000 for individuals and $4,000 for couples.
Donate your IRA distribution to charity
Retirees typically need to pay income tax on withdrawals from traditional retirement accounts. However, retirees ages 70 1/2 or older who directly transfer their IRA withdrawals of up to $100,000 to a qualified charity will not owe income tax on the distribution.
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How to Reduce Your Tax Bill by Saving for Retirement originally appeared on usnews.com