Your retirement plan’s secret weapon
Did you know that your retirement plan has a secret weapon? That’s right. Not only can it help you save money for retirement, but it can also help you save current income taxes. That means, you can keep more money in your pocket and save for retirement at the same time, just by contributing to your employer’s retirement plan.
How to lower your current taxes
Each time you make a contribution to your employer retirement plan, you lower the amount of income that can be taxed. That’s because your contributions go into your account before taxes come out (that’s why they’re called “pre-tax contributions”). Once you’ve made a pre-tax contribution, federal (and possibly state and local) income taxes are calculated and taken out of your paycheck.
Because you’ll have less income to tax, you’ll pay less in current taxes. This can leave you with more pay to spend than if you had paid taxes first and then saved the same amount outside the plan (by making an after-tax contribution).
Pre-tax vs. after-tax savings
Let’s say you earn $50,000 per year and contribute $5,000 (10% of your pay) to your retirement plan. Your pre-tax contribution shaves $5,000 off of your taxable income. If you had instead chosen to save $5,000 in a regular savings account (after taxes), you would have owed tax on the full $50,000, leaving you with a higher tax bill and $1,250 less in spendable income.
Advantage of pre-tax saving (hypothetical example)
Assumes a 10% savings rate and a 25% federal income tax rate
This example takes into account only federal income taxes and does not 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. Example 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.
Higher contributions can save you more
Increasing your pre-tax contributions would cut the amount of income you’re taxed on currently. So the more you contribute to your plan, the more you may be able to lower your current taxes.
You may be in a lower tax bracket
Your contributions and any investment income earned on them won’t be taxable until the money is distributed to you – when you decide to withdraw it, typically in retirement. Although future tax rates can’t be predicted, it’s possible that you’ll be in a lower tax bracket when you retire. Because of this, the tax rate on withdrawals from your plan at that time could be lower than the rate that would apply to taxable income during your working years.
The Saver’s Tax Credit
Did you know that you could reduce your tax bill by up to $1,000, just by saving for retirement? Savers with low to moderate incomes can deduct part of their retirement plan or IRA contributions as a credit — on top of the tax advantages their plan provides. The credit equals 50%, 20% or 10% of the contribution, up to $2,000 ($4,000 if you are married and file your taxes jointly), depending on their Adjusted Gross Income (AGI). Talk to your financial professional to see if you qualify.
Important Note: Equitable believes that education is a key step toward addressing your financial goals, and we’ve designed this material to serve simply as an informational and educational resource. Accordingly, this article does not offer or constitute investment advice and makes no direct or indirect recommendation of any particular product or of the appropriateness of any particular investment-related option. Investing involves risk, including loss of principal invested. Your needs, goals and circumstances are unique, and they require the individualized attention of your financial professional. But for now, take some time just to learn more.
This article is provided for your informational purposes only. Please be advised that this document is not intended as legal or tax advice. Accordingly, any tax information provided in this document is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. The tax information was written to support the promotion or marketing of the transaction(s) or matter(s) addressed and you should seek advice based on your particular circumstances from an independent tax advisor.
Equitable Financial Life Insurance Company (New York, NY) issues life insurance and annuity products. Securities offered through Equitable Advisors, LLC, member FINRA, SIPC. Equitable Financial Life Insurance Company and Equitable Advisors are affiliated and do not provide tax or legal advice.