Reduce Your Taxes

If you invest in a retirement plan through your employer or a traditional IRA, you may not be aware of all the tax advantages. Here are a few reasons why you might want to increase your contributions to them.

This Year’s Tax Bill

Your employer deducts contributions made to your 401(k) plan before taxes are calculated, reducing the amount of your reportable income. With less taxable income, you’ll pay less to the federal government and your local tax jurisdiction.

For example, contribute an extra $100 per month in 2018 and you would increase your annual retirement contributions by $1,200. If you have a 25% combined tax rate, counting both your federal and local taxes, you will owe $300 less than if you had not made the extra contribution at all. In this way, your retirement plan contributions benefit you now and in the future.

The IRA Way

Depending on your income, contributions to a traditional IRA may also be tax-deferred. Even if your income is too high to qualify for tax deferral, potential earnings are tax-deferred. You will pay taxes only on the amount of eventual withdrawals you take, when you could be in a lower tax bracket than you are now.

Potential Earnings

Because earnings in these retirement accounts are tax-deferred, you get more bang for your investing buck. Each year, every dime of the tax-deferred gain accumulates. Meanwhile, you’ll pay tax on dividends and taxable gains of investments in the year they’re earned.

Over time, the tax-deferred account will become larger compared to the taxable account when they hold the same investments. This shows that time and compounding, combined with tax-deferred potential growth, can really benefit your future retirement income.

Still Time

At a minimum, try to contribute at least what your employer will match in a 401(k) plan. And if you qualify for tax-deductible IRA contributions, you have until your tax filing deadline to contribute more.