10 Tax Breaks for Retirement Savers
By Emily Brandon
Saving for retirement can decrease your tax bill or boost your refund. But there are also penalties if you take money out of retirement accounts too early or too late. Here's how to minimize taxes on your retirement savings.
Employees can defer paying income tax on up to $18,000 they contribute to a traditional 401(k), 403(b) or the federal government's Thrift Savings Plan in 2015. Income tax won't be due on this money until it is withdrawn from the account.
You can defer income tax on up to $5,500 by contributing to a traditional individual retirement account in 2015. IRA contributions aren't due until April 15, so you can make a contribution shortly before filing your taxes to reduce your tax bill or boost your refund.
Roth IRAs have the same contribution limits as traditional IRAs, but the tax treatment is different. Roth IRA contributions are made with after-tax dollars, but withdrawals in retirement are tax-free.
Roth 401(k)s don't offer a tax break in the year you make a contribution, but your savings grow without the drag of taxes, and you won't be taxed for withdrawals in retirement from accounts that are at least five years old.
Workers ages 50 and older can contribute an extra $6,000 to a 401(k) and $1,000 to an IRA as catch-up contributions to boost their retirement nest egg and realize even bigger tax savings. However, you can no longer contribute to a traditional IRA once you reach age 70½.
Workers with adjusted gross incomes below $30,500 for singles, $45,750 for heads of household and $61,000 for married couples in 2015 can claim the saver's credit in addition to the tax deduction on their retirement account contributions. The credit is worth between 10 percent and 50 percent of the amount saved in a 401(k) or IRA, up to $2,000 for individuals and $4,000 for couples, with bigger credits going to people with lower incomes.
Avoid the early withdrawal penalty.
Retirement account withdrawals before age 59½ typically trigger a 10 percent early-withdrawal tax. But there are a variety of ways to avoid the penalty if you use an IRA withdrawal for certain purposes, such as college costs, buying a first home, paying for large medical bills or purchasing health insurance after a job loss.
Remember to take required minimum distributions.
Withdrawals from 401(k)s and traditional IRAs become required after age 70½. Required minimum distributions are typically calculated by dividing the account balance by an IRS estimate of your life expectancy. Those who fail to withdraw the correct amount face a stiff 50 percent tax penalty on the amount that should have been withdrawn.
Delay 401(k) withdrawals while working.
If you remain employed after age 70½ and don't own 5 percent or more of the company you work for, you can delay withdrawals from your current 401(k), but not IRAs or 401(k)s from previous jobs, until you actually retire.
Time your retirement account withdrawals.
If you accumulate savings in traditional and Roth retirement accounts and taxable investment accounts, you will have some control over how much you will pay in taxes each year because you can time your withdrawals from each type of account. While you will owe income tax on withdrawals from traditional 401(k)s and IRAs, your Roth IRA distributions will provide tax-free retirement income.