10 Ways to Reduce Taxes on Your Retirement Savings

Try these strategies to minimize taxes on money you will use for retirement.

10 Ways to Reduce Taxes on Your Retirement Savings

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Defer or prepay your taxes.

There are a variety of tax deductions and credits available to people who save for retirement. Contributing to a retirement account, such as a 401(k) or individual retirement account, can help you reduce your tax bill. You may be able to defer paying income tax on your retirement savings until retirement. However, you could also incur tax penalties if you don't use your retirement accounts correctly. Here's how to minimize taxes on your retirement savings.

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401(k)

Contributing to a traditional 401(k) plan allows you to defer paying income tax on your retirement savings until the money is withdrawn from the account. Most workers are eligible to defer taxes on up to $20,500 in 2022 that is deposited in a 401(k), 403(b) or the federal government's Thrift Savings Plan. If these contributions are made via a payroll deduction, you will get the tax break almost immediately because less money will be withheld for income taxes.

Next:

Defer or prepay your taxes.

There are a variety of tax deductions and credits available to people who save for retirement. Contributing to a retirement account, such as a 401(k) or individual retirement account, can help you reduce your tax bill. You may be able to defer paying income tax on your retirement savings until retirement. However, you could also incur tax penalties if you don't use your retirement accounts correctly. Here's how to minimize taxes on your retirement savings.

401(k)

Contributing to a traditional 401(k) plan allows you to defer paying income tax on your retirement savings until the money is withdrawn from the account. Most workers are eligible to defer taxes on up to $20,500 in 2022 that is deposited in a 401(k), 403(b) or the federal government's Thrift Savings Plan. If these contributions are made via a payroll deduction, you will get the tax break almost immediately because less money will be withheld for income taxes.

Roth 401(k)

The contribution limits for Roth 401(k)s are the same as for traditional 401(k)s, but the tax treatment is different. You don't get an immediate tax break on your Roth 401(k) contributions. Roth 401(k)s allow you to contribute after-tax dollars, but then you can accumulate tax-free investment growth and take tax-free withdrawals after age 59 1/2 from an account that is at least five years old. The investment earnings within the account are not taxed each year, and you can withdraw the balance tax-free in retirement.

IRA

People with earned income who save for retirement in an individual retirement account can defer income tax on up to $6,000 in 2022. However, you may not be able to claim a tax deduction for your IRA contribution if you also have a 401(k) account at work and earn more than a certain amount. The IRA tax deduction is phased out for 401(k) account participants who earn between $68,000 and $78,000 in 2022 ($109,000 and $129,000 for couples). If only one spouse has access to a 401(k) plan at work, the tax break is phased out if the couple's income is $204,000 to $214,000 in 2022.

Roth IRA

Taxpayers can prepay income tax on up to $6,000 in 2022 using a Roth IRA. Contributing to a Roth IRA can qualify you for tax-free investment growth and tax-free withdrawals in retirement from accounts at least five years old. However, the ability to make Roth IRA contributions is phased out if your adjusted gross income is between $129,000 and $144,000 as an individual and $204,000 to $214,000 as a married couple. However, people who earn more may still be eligible to convert traditional retirement account assets to a Roth.

Catch-up contributions

Workers age 50 and older are eligible for an additional tax break if they make catch-up contributions to their retirement accounts. Older employees can defer taxes on an additional $6,500 in a 401(k) plan for a total tax-deductible contribution of as much as $27,000 in 2022, compared with $20,500 for younger workers. IRAs also allow catch-up contributions for those age 50 and older of up to $1,000 in 2022. Older workers can make a tax-deductible IRA contribution of as much as $7,000.

Saver's credit

Retirement savers who earn up to $34,000 for individuals, $51,000 for heads of household and $68,000 for married couples in 2022 and contribute to a 401(k) or IRA are eligible for the saver's credit. The saver's credit can be claimed on retirement account contributions of up to $2,000 ($4,000 for couples) and is worth between 10% and 50% of the amount contributed, with bigger credits going to savers with lower incomes. The saver's credit can be claimed in addition to the tax deduction for a traditional retirement account contribution.

Avoid the early withdrawal penalty.

IRA withdrawals before age 59 1/2 and 401(k) withdrawals before age 55 generally result in a 10% tax penalty. However, there are a variety of ways to avoid the early withdrawal penalty. You may not have to pay a penalty for an early withdrawal if you use the money for several specific purchases, such as an IRA distribution for college costs, a first home purchase (up to $10,000), abnormally large health care costs or health insurance after a layoff. You may also be able to withdraw funds that you contributed to a Roth IRA, but not the earnings, without triggering the early withdrawal penalty if the Roth IRA is at least five years old.

Remember required minimum distributions.

Withdrawals from IRAs and most 401(k)s become required after age 72. Income tax will be due on each traditional retirement account distribution. The penalty for failing to withdraw the correct amount is a stiff 50% of the amount that should have been distributed, in addition to the income tax due. Your first required minimum distribution is due by April 1 of the year after you turn 72, but all subsequent distributions must be taken by Dec. 31 each year to avoid the penalty.

Delay 401(k) withdrawals if you are still working.

If you remain employed into your 70s or later and don't own 5% or more of the company sponsoring the retirement plan, some 401(k) plans will allow you to delay withdrawals from your current 401(k) account until you actually retire. However, you will still need to take required minimum distributions from IRAs and 401(k) accounts associated with previous jobs after age 72 to avoid the 50% tax penalty.

Time your retirement account withdrawals.

Retirees have some flexibility in the timing of their retirement account withdrawals and the resulting income tax bill. Some retirees control their tax rate by spacing out their withdrawals to avoid a big income tax bill in a single year and stay in a lower tax bracket. During your 60s, you can take penalty-free withdrawals from your retirement accounts, but you are not yet required to take distributions each year. Taking retirement account distributions in a low-earning year can help you to minimize taxes on your retirement savings.

How to reduce taxes on your retirement savings:

  • Contribute to a 401(k).
  • Contribute to a Roth 401(k).
  • Contribute to an IRA.
  • Contribute to a Roth IRA.
  • Make catch-up contributions.
  • Take advantage of the saver's credit.
  • Avoid the early withdrawal penalty.
  • Remember required minimum distributions.
  • Delay 401(k) withdrawals if you are still working.
  • Time your retirement account withdrawals.
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Updated on May 9, 2022: This story was published at an earlier date and has been updated with new information.

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