How Retirement Contributions Impact Your Tax Bill
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We all know how important it is to save for retirement. If you’ve started contributing to a retirement plan, at work or on your own, the next thing you’ll want to know is how to deal with it on your tax return.
Fortunately, entering retirement contributions on your tax return is pretty simple. Here are some common questions and the answers you may need.
Can I deduct my contributions to a retirement plan?
You can generally deduct contributions to a traditional (not Roth) Individual Retirement Arrangement (IRA), 401(k) plan, or similar arrangement, up to an annual limit. That may reduce your income tax for the current year.
How do I know what my contribution limit is?
In 2023, you can deduct contributions of up to $6,500 to a traditional IRA ($7,500 if you are age 50 or older by the end of the tax year). This is up from $6,000 in 2022.
Other plans have different limits, which vary based on your age and type of plan. They may also be limited based on your income level.
When you enter your information in TaxAct®, our program calculates your maximum retirement plan contribution for you.
Why can’t I deduct contributions to a Roth IRA or other Roth retirement plan?
With a Roth IRA or other plan, you cannot deduct your contributions. However, when you meet the requirements and take withdrawals from a Roth plan after retirement, you pay no tax on those withdrawals.
You must choose between one tax benefit or the other – depending on your situation, either could be a good option!
How do I deduct contributions that were deducted from my paycheck?
If your employer deducted retirement contributions from your paycheck throughout the year for an employer-sponsored retirement plan, your taxable income on Form W-2 will reflect that deduction already. You don’t need to take a deduction elsewhere on your return.
You enter the information from each box on Form W-2, exactly as shown. If you use tax software to file your return, the program should take care of the rest for you.
Do I have to pay tax on my employer contributions to my retirement plan?
You do not generally include qualified employer contributions to your employer-sponsored traditional retirement plan until you withdraw the money, generally in retirement.
What are the income tax benefits of retirement plans?
Both traditional and Roth retirement plans offer considerable tax benefits. For traditional retirement plans, you get a deduction now for your contributions. Your account balance grows tax-free until you take money out of it, and then you pay regular income tax on your withdrawals. If your total taxable income is lower in retirement, you may be in a lower tax bracket than you were in your prime earning years.
With Roth plans, you don’t get the initial deduction for contributions. However, after the account grows over the years and you take withdrawals, you don’t pay tax on any of it if you meet the requirements. That means all your gains from the years you were tucking money away are not taxed.
What other benefits do retirement plans offer?
The most important thing about any type of retirement plan may be that they motivate you to put money away every year. If you have a plan that deducts money from your paycheck, or that automatically transfers an amount from your bank account regularly, making the contribution can be almost painless.
Retirement plans and pension plans may also offer protection from creditors, should you ever have debt problems. They may also be part of a comprehensive estate plan.
Can contributing to an IRA change my tax bracket?
It’s possible that contributing to an IRA or another traditional retirement plan may change your top tax bracket, assuming your taxable income is near a bracket level. However, it may not have as much effect as you think. Changing your top bracket doesn’t change your rates on the rest of your income, because each level of your income is taxed at the income tax rate for that bracket.
What are catch-up contributions?
The IRS allows individuals over age 50 to contribute an additional amount to some types of retirement accounts. For example, you can contribute $6,500 to a traditional IRA in 2023 if you are under age 50. Once you hit age 50, you can contribute up to $7,500. You don’t have to show that you are “behind” in order to make a “catch-up” contribution.
Should I make retirement plan contributions in years when I have a lower taxable income?
If you are deciding which year to make a deductible contribution to a retirement plan, choose the year when you are in the highest tax bracket. You’ll get the most benefit from your deduction. However, if you can keep making steady contributions every year, without sacrificing other financial needs and goals, your retirement planning will be more successful than if you only make contributions when financial times are good.
What’s a good amount to contribute to a retirement plan?
That’s a hard question because it depends on how far you are from retirement, how much you can afford to contribute, and your investments outside of retirement, among other things. However, many experts recommend you save 10-20 percent of your income throughout your working life.
When can I make retirement plan contributions?
It depends on the type of plan. You can open an IRA and contribute to it up to the original due date of your tax return, usually April 15 of the following year. You can make contributions to your 401(k) plan or 403(b) plan until Dec. 31 of the tax year. Always feel free to reach out to your plan administrator or your employer if you have questions.
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This article is for informational purposes only and not legal or financial advice.
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