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Ask Our Taxes Expert

Have a question? Ask our Taxes expert.

Have questions? Email Send your question to jmansfield@smartasset.com

Ask Our Taxes Expert

Have a question? Ask our Taxes expert.

Have questions? Email Send your question to jmansfield@smartasset.com

save on taxes

Want to reduce your tax bill? Consider boosting your retirement savings. That way, you’ll be paying your future self instead of the government. We’re not advocating that you stash your money in the Cayman Islands, of course. But why pay more taxes than you need to? Instead, set yourself up for a comfortable retirement and reap the benefits when tax time rolls around.

Let’s be clear: finding yourself in a high tax bracket with a hefty tax bill is, quite literally, a “rich person problem.” But hey, problems are problems. If you want to reduce your tax bill, one good way of doing so is to save, save, save.

Max out Your 401(k)

For starters, you can focus on maxing out your 401(k) each year. Contributions to your company’s 401(k) immediately lower your taxable income. Take a look at how much you’re making in contributions each year. Compare that to how much you could be contributing. If you can afford to boost your contributions to the max, you should consider doing so. This is especially true if maxing out your 401(k) would knock you into a lower tax bracket.

You’ll also want to assess the funds you’ve chosen for your 401(k). Each investment will have its own fees. If you have a financial advisor managing the account for you, they can charge their own fees, as well. You’ll want to make sure your account is filled with low-cost funds and your manager charges low fees.

Max out a Traditional IRA

save on taxes
The same taxable income-reducing principle applies to a traditional IRA as to a 401(k). When you contribute to a traditional IRA, you can deduct those contributions from your income at tax time. This will lower your tax liability now. However, don’t forget that you’ll pay taxes on that money when you make withdrawals in retirement.

The amount of your IRA contribution that you can deduct depends on a couple things. One is your income. The second factor is whether you or your spouse (if you’re married and filing jointly) has a retirement plan through work. If you’re single and don’t save for retirement through your employer, you can make a tax-deductible contribution of up to $5,500 regardless of your income. That number becomes $6,500 if you are 50 or older.

Just like with your 401(k), you’ll want to maximize your IRA savings by optimizing the investments inside the account. For starters, your portfolio should reflect a diversified selection of investments. This will be an ongoing effort since your tax bracket, age and the market will change over time. You’ll want to adjust your investments according to those changes to make sure the account is still performing at its peak.

Consider Opening a SEP IRA

SEP IRAs offer a retirement savings vehicle for self-employed workers and small business owners. You qualify for a SEP IRA if you’re a small business owner, sole proprietor or consultant. Plus, if you can employ your spouse and/or children, that can shift wealth to them while lowering the family’s tax liability. Everybody wins!

You also qualify if you have a side gig that earns income, offering a great way to lower your taxable income. Just always be mindful of SEP IRA contribution limits as with any other retirement account. That way you can maximize your savings to the legal amount, avoiding any penalties.

Open a Roth IRA

Ever wonder what the difference is between a Roth IRA and a traditional IRA? The answer lies in the taxes. While you fund a traditional IRA with pre-tax money, you fund a Roth IRA with after-tax money. This means that when you withdraw funds from a Roth IRA during retirement, you don’t have to pay taxes on those amounts. This system helps those who expect to be in a higher tax bracket in retirement as opposed to the present.

Instead of opening an entirely new retirement account, you also have the option of making a Roth IRA conversion. This allows you to convert a traditional IRA to a Roth IRA. To start the process, you’ll have to contact the institution that holds your traditional IRA to learn more about their processes. Converting to a Roth IRA makes sense when you already have taxable accounts like a 401(k). It prevents all your retirement income from being subject to taxes when withdrawn.

Don’t Forget to Give

save on taxes

Does your income and phase of life make giving away large sums of money an appealing prospect? If so, that can be a great way to save on taxes. Giving money to your children isn’t an official retirement plan, of course. However, many of us go into retirement expecting our kids to help out in those later years. That means giving them a financial cushion probably won’t hurt you in the long run. Plus, it decreases your taxable income now. But remember there are limits about how much you can give to an individual each year without needing to file a gift tax return. You and your spouse can each give $14,000 to an individual in a year.

The Takeaway

We bet you never thought that saving for retirement could help lower your taxes. The above strategies can help you do that successfully. They decrease your taxable income to cut your tax bill. However, it’s also for a good reason: saving for retirement! This double benefit helps you out now and in the long run to enjoy a richer life and retirement.

Tips on Saving for Retirement

  • Lowering your taxes now is all good and well, but don’t forget about your taxes in retirement. Where you choose to settle down also affects your retirement tax friendliness along with the retirement accounts you have.
  • It’s also important to save as much as you can for retirement. The strategies above will help you with that. But even if you’re not looking to reduce your taxes, maxing out your retirement accounts still cushions your future.

Photo credit: ©iStock.com/monkeybusinessimages, ©iStock.com/Wavebreakmedia, ©iStock.com/lovelyday12

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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