Are you planning for retirement by saving now? While you probably know that it’s a smart investment in your future, you may not be aware that retirement savings can net you some extra benefits at tax time. Retirement savings can positively affect your tax situation, though you are still responsible for any penalties or fees assessed for late or early withdrawals. There are several different types of retirement savings accounts, so depending on the type you have, the following tax facts apply:
- 401(k): if you want to save immediately, you can chose to defer paying the income tax on your contributions, and won’t be responsible to pay it until you withdraw the funds. You are allowed to defer tax on up to $18,000 of contributions to a 401(k), 403(b), or a Thrift Savings Plan.
- IRA: similar to the rules for a 401(k), you can defer tax on up to $5,500 of contributions made to a traditional IRA plan. You should consider making a contribution right before you file your taxes, as it can lower your tax obligation and possibly grant you a bigger refund.
- Roth IRA: money put into a Roth IRA is subject to the same limitations as a traditional IRA, however the contributions are made after taxes. When you begin distributions during retirement, the money is tax-free.
- Roth 401(k): while the tax benefit for this type of account isn’t immediate, you aren’t required to pay taxes on any withdrawals from accounts you’ve had longer than five years. Additionally, your savings can multiply with the worry of taxation on your contributions.
Other Retirement Savings
If you are an employee over the age of 50, you are eligible to add $6,000 to a 401(k) or IRA savings plan above the usual limitations. Traditional IRA contributions are finished at the age of 70 ½ so it’s important to plan as necessary.
Early withdrawals can be damaging to both your taxes and your retirement accounts. Early withdrawals occur when a taxpayer takes a distribution of their savings before age 59 ½. The withdrawals are taxed 10%, although exceptions are in place if the money is withdrawn from an IRA and used for college, first home purchase, medical bills, or health insurance.
After the age of 70 ½, you are required to begin distribution from your traditional IRA and 401 (k) plans. If you don’t take a minimum withdrawal amount, you could be penalized at up to 50% tax rate. You can delay your distributions from your current employer if you are still working at age 70 ½ and own less than 5% of the company.
Don’t forget about the Saver’s Credit. It’s in addition to other tax deductions for employees who file Single status and have an adjusted gross income of less than $30,500 ($45,750 head of household, $61,000 for married status). This credit benefit is between 10% and 50% of your current retirement savings, up to $2,000 for single filers, and $4,000 for couples. Basically, the less you make, the bigger you’ll get credit-wise.