Saving for retirement is generally considered a form of deferred gratification. You choose not to spend some of your money now in exchange for more money when you retire. But that’s too simplistic a way of looking at it.
Although you won’t realize the full benefits of saving for retirement until you withdraw your funds, there are still some benefits you can enjoy today. Here are three.
1. You will get tax relief if you contribute to a tax-deferred account
Retirement accounts generally fall into two types: tax-deferred and Roth. Roth accounts require you to pay taxes on your contributions now in exchange for tax-free withdrawals in retirement. But tax-deferred accounts give you upfront tax relief on your contributions. However, you must pay taxes on your retirement withdrawals.
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The type of tax deduction you receive depends on the amount of your contribution. If you put $5,000 into a traditional IRA, for example, the government reduces your taxable income for the year by $5,000. It is sometimes possible to knock you out of a tax bracket through tax-deferred pension contributions, which means you will owe a smaller percentage of your income to the government.
Most retirement accounts are tax-deferred, including most 401(k)s and traditional IRAs, so they’re not too hard to find. Roth accounts usually state that they are Roth in the name, so it’s simple to determine when each account requires you to pay taxes.
2. You could earn the Saver’s Tax Credit
The Saver’s Tax Credit is a tax relief available to adults 18 years of age or older who are not students or who are claimed as a dependent on someone else’s tax return. Unlike the tax deduction mentioned above, this is a tax credit, meaning it is a dollar-for-dollar reduction in your tax bill. This means that if you qualify for a $1,000 tax credit and your tax bill for the year was $5,000, you only owe the government $4,000.
The maximum investor tax credit for the 2022 tax year is $2,000 for single adults and $4,000 for married couples. But how much you’re entitled to depends on how much you put into your retirement account and your adjusted gross income (AGI). The higher your income, the smaller your credit, and some very high-income people may not qualify for the credit at all.
But if you do, you can save hundreds or thousands of dollars on your tax bill this year. This could result in a smaller amount owing or a larger tax refund when you file your return.
3. You can get more money from your job if you qualify for a 401(k) match
Some employers offer employees a company match if they are willing to divert some of their own earnings to their 401(k). The size of this match depends on the company’s match formula and the individual’s salary, as well as the amount they choose to contribute to their retirement account. But in some cases, it can add up to thousands of dollars a year. And that could turn into tens of thousands of dollars over time once it’s been invested long enough.
The same rules apply to your own contributions and those your employer makes on your behalf. You cannot withdraw the funds before age 59.5 without paying a 10% early withdrawal penalty plus taxes, unless you have a valid reason. But you still make a little extra money from your job each year, which can make it more interesting.
Hopefully, the three tips above will inspire you a little more to put aside some money for retirement this year if you haven’t already. You must make all 401(k) contributions by the end of the year, but you can make 2022 IRA contributions until the tax filing deadline. Consider which accounts are best for you and plan accordingly.
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