Did you know you can reduce your tax bill by contributing to a 401(k) plan or individual retirement account? Here is how traditional retirement accounts can be used to control how much you might potentially owe this tax season, or into the next.
Boost Your 401(k) Savings Rate
Most people have their 401(k) on auto pilot and forget that they may be able to increase their contributions just by logging in to their retirement plan’s account and increasing their withholding. By doing so, this may help you achieve retirement goals faster and help at tax time by qualifying you for a larger tax break.
For example: a worker in the 22 percent tax bracket who contributes $10,000 to a 401(k) plan may reduce his tax bill by $2,200. However, workers can contribute as much as $19,000 to a 401(k) plan in 2019 (up from $18,500 in 2018). If that same worker boosted his contribution to max out his 401(k) plan he may save $4,180 at tax time
Workers age 50 and older are eligible to make catch up contributions to 401(k) plans for an additional $6,000. A 55-year-old employee in the 24 percent tax bracket who maxes out her 401(k) by contributing $24,500 might save $5,880 on taxes.
Your exact tax savings will depend on your tax bracket. Married couples who are both eligible for a 401(k) plan at work can max out a 401(k) in each of their names for double the tax savings.
Make an IRA Contribution
Contributions to a traditional individual retirement account can be tax-deductible in the year you make them. While different IRS rules on IRA contributions apply to differing situations, you can generally deduct the full amount of an IRA contribution if you and your spouse aren't covered by retirement plans at your place of work. If you are, your contribution might be limited based on your adjusted gross income.
If you qualify, an IRA contribution can be a great way to reduce this year's taxes. For example, if you are in the 25 percent tax bracket and make a $5,500 deductible contribution (the maximum amount for 2018) you could save as much as $1,375 in taxes based on 2018 tax rates. Best of all, you can contribute to an IRA all the way until tax filing day, April 15. Most other tax-saving strategies must be in place by December 31.
Claim the Tax Saver’s Credit
Workers with smaller salaries who manage to save for retirement may be able to claim a tax credit in addition to the tax deduction for saving in a traditional 401(k) or IRA. You may be eligible for the saver’s credit for this year’s tax season if you are: 1) Age 18 or older; 2) Not a full-time student; 3) Not claimed as a dependent on another person’s return. To view a projected amount of the credit, please visit the IRS website at www.irs.gov and search for “Retirement Savings Contributions Credit.”
Donate Your IRA Distribution to Charity
Retirees are required to take distributions from traditional 401(k)s and IRAs each year after age 70 ½ and pay income tax on each withdrawal. However, IRA owners age 70 ½ and older can avoid taxes on distributions that they donate directly to a qualifying charity. You can distribute up to $100,000 to an eligible charity without paying income tax on the transaction, and the donation can also be used to satisfy your minimum distribution requirement. Couples who file a joint tax return can avoid paying income tax on up to $200,000 in IRA charitable donations. You do not need to make a large donation to qualify for the tax break. Even donating $100 directly from your IRA to a charity would save you $24 in taxes if you are in the 24 percent tax bracket. Qualified charitable contributions must be executed by December 31 to qualify for the tax break.
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