Your retirement plans' secret weapon

Your retirement plan can do more than help you save money for retirement – it can also help you keep more money in your pocket now. By contributing to your employer’s retirement plan, you can save on your current income taxes and save for retirement at the same time. Think of it as a win-win for both your present and your future.

How your retirement plan can help lower your current taxes

Each contribution you make to your retirement plan goes into your account before income taxes are applied (that’s why they’re called “pre-tax contributions”). After you’ve made a pre-tax contribution, federal (and possibly state and local) income taxes are calculated based on the remaining amount and taken out of your paycheck. By making a pre-tax contribution, you reduce your taxable income, so you’ll pay less in current taxes.

Understanding the benefits of pre-tax savings

Let’s say you earn $50,000/year. If you contributed $5,000 (or 10%) to your retirement plan, it would be a pre-tax contribution and lower your taxable income to $45,000. If you had chosen to save the same $5,000 in a regular savings account instead, it would be an after-tax contribution so your taxable income would still be $50,000 and your tax bill would be higher. In this example, choosing to make a pre-tax contribution to your retirement plan instead of an after-tax contribution outside of your plan would give you $1,250 more in spendable income, thanks to a reduced tax bill.

Here’s a hypothetical example of pre-tax vs after-tax savings

The example below assumes a 10% savings rate and a 25% federal income tax rate.

This example only considers federal income taxes and doesn’t consider state or local taxes or other payroll adjustments. Withdrawals made prior to age 59½ may be subject to a 10% federal income tax penalty and are subject to plan restrictions. This example also assumes that all income is taxed at an average rate of 25%, whereas federal tax rates increase gradually as taxable income rises over specified levels.

The more you contribute, the more you can save

By increasing the amount of your pre-tax contributions to your retirement plan, you can lower your current taxes even further by reducing your taxable income even more.

Make the most of a lower tax bracket in retirement

The pre-tax contributions you make to your retirement plan and any investment income you earn isn’t taxed until you receive your money by taking withdrawals in retirement. While it’s impossible to predict future tax rates, you may be in a lower tax bracket in retirement than you were during your working years, so you may owe less in taxes.

The Saver’s Tax Credit could help you save even more

With the Saver’s Tax Credit, you could reduce your tax bill by up to $1,000, just by saving for retirement. If you earn a low-to-moderate income, you can deduct part of your retirement plan or IRA contributions as a tax credit. The credit equals 50%, 20% or 10% of the contribution, up to $2,000 ($4,000 if you’re married and file your taxes jointly), depending on your Adjusted Gross Income (AGI). To learn more and see if you qualify, talk to your financial professional.