How Retirement Plan Contributions Can Help You Save on Taxes
Saving for retirement is a smart financial move, but did you know it can also help reduce your taxes? By contributing to your employer-sponsored retirement plan, you can lower your taxable income, enjoy tax-deferred growth and potentially even land in a lower tax bracket — all while building a nest egg for your future. Let’s break down the tax-saving benefits of your 401(k) or 403(b) plan.
It Lowers Your Taxable Income Now
One of the primary benefits of contributing to a 401(k) or 403(b) is that it lowers the amount of income subject to taxes. Here’s how it works: The money you contribute to your company-sponsored retirement plan is deducted from your paycheck before taxes are applied. This means the income you’re taxed on — your “taxable income” — is reduced by the amount of your contribution, up to allowable limits. The immediate tax savings can help ease the financial impact of setting money aside for retirement.
You Pay Less in Taxes Later … Maybe
Contributing to an employer-sponsored retirement plan gives you the ability to defer taxes on your contributions (including any employer match) until retirement, potentially allowing you to pay a lower tax rate when you eventually withdraw the funds. For example, if you contribute $5,000 to your 401(k) while in a 32% tax bracket, that amount is subtracted from your taxable income, lowering your tax obligation when you file. Then, suppose you’re in a 22% tax bracket when you withdraw funds in retirement — in that instance, you’d also be paying a much lower tax rate on those distributions. Keep in mind, however, that if your income rises or tax laws change, you could find yourself in a higher bracket, with a larger tax burden.
You Can Enjoy Tax-deferred Growth
Company-sponsored retirement plan contributions grow tax-deferred. This means earnings on your investments aren’t taxed until you withdraw the funds in retirement. Why is this a big deal? When returns get reinvested over the years without being reduced by taxes, it can make a significant difference in how much your portfolio grows by the time you retire.
It Could Lower Your Tax Bracket
Depending on how much you earn and how much you contribute, lowering your taxable income with retirement plan contributions may place you in a lower tax bracket. This would result in your overall income being taxed at a lower rate, further amplifying the benefit of saving through your employer-sponsored retirement account.
Shrink Your Tax Bill and Boost Your Nest Egg
Contributing to your 401(k) or 403(b) plan can make your money work harder for you, both now and in the future. If you’re not contributing to your company-sponsored retirement plan yet, or if you’re unsure whether you’re maximizing the benefits available to you, consider speaking with a Financial Professional to help you save on taxes and lay the groundwork for a more secure retirement.
Source
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-benefits-of-saving-now