Can You Cut $4,500 From Your 2017 Tax Bill?

By Chuck Saletta Markets Fool.com

Much of what you do as a successful investor will result in you paying more in taxes. Close out an investment for a profit? Pay a capital gains tax. Receive a dividend? Pay a dividend tax. Own a mutual fund? Pay taxes on those year-end distributions. But there's one incredibly smart move you can make as an investor that can potentially cut $4,500 -- or maybe even more -- from your 2017 tax bill.

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That move? Contribute to your traditional 401(k) at work. Every penny you contribute to your traditional 401(k) plan reduces your taxable income, which reduces the income tax you pay during the year you contribute it. Even better, that money grows tax deferreduntil withdrawn from your account, meaning those previous investment successes won't trigger immediate taxes on money that remains in your plan.

How much can you cut your 2017 taxes?

The tax benefit you get from contributing depends on how much you contribute and what marginal tax bracket that money would have otherwise fallen in. The table below shows your potential tax savings from contributing the maximum allowed by current rules (though your contribution may be further limited, particularly if you're considered a "highly compensated employee"):

Under 50

Age 50+

2017 Contribution Limit

$18,000

$24,000

Tax Savings, 10% Bracket

$1,800

$2,400

Tax Savings, 15% Bracket

$2,700

$3,600

Tax Savings, 25% Bracket

$4,500

$6,000

Tax Savings, 28% Bracket

$5,040

$6,720

Tax Savings, 33% Bracket

$5,940

$7,920

Tax Savings, 35% Bracket

$6,300

$8,400

Tax Savings, 39.6% Bracket

$7,128

$9,504

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Data source: U.S. Internal Revenue Service. Table by author.Tax savings assumes contribution at the listed limit and that all deducted income would have fallen in the listed bracket.

There are two ways to look at the tax benefit you get from contributing to your traditional 401(k). First, the direct benefit is that the tax check you'll have to write to Uncle Sam will be that much lower thanks to your contribution reducing your taxable income.

Second, the money you're contributing is that much less expensive for you than contributing it to an after-tax brokerage account. If you contribute $18,000 to your traditional 401(k) plan and are in the 25% tax bracket, the $4,500 tax reduction means the contribution only cost you the equivalent of $13,500 in after-tax cash.

Save taxes now, build a nest egg for tomorrow

Even more important than the tax savings that come from contributing to your traditional 401(k) plan is the fact that the money you contribute to that plan can grow, tax deferred, for your future. If you want an idea of how quickly your money can grow, consider using the shorthand trick known as the Rule of 72. You simply divide 72 by the rate of return you expect to earn with your money, and the result will estimate how long it will take your money to double for you.

For instance, if you expect to earn 8% per year, you'd divide 72 by 8 to end up with 9 -- indicating that your money would double in about 9 years. Likewise, if you're expecting 6% annual returns, you'd divide 72 by 6 and figure out that your money would double in about 12 years. Over the long run, stock market returns have been in the neighborhood of 10% per year, which, by the rule of 72, would indicate your invested money could potentially double every 7.2 years.

Using those estimates, if you have 30 or so years left until you retire, that 10% return rate would mean your money could potentially double about four times over. With a single doubling, $10,000 turns into $20,000. With a second doubling, it becomes $40,000. With a third doubling, it'd turn into $80,000, and with a fourth doubling, that initial $10,000 investment would become a whopping $160,000.

With all of that potential doubling taking place inside your 401(k) plan, your money can continue to grow for you tax deferred until it's time for you to withdraw it in retirement. Even better, all of that growth is possible from a single year's investment. You will likely be able to invest in your 401(k) at work every year you're employed, making your 401(k) plan a great tool to potentially propel you to millionaire status by retirement. That's the real power of contributing to your 401(k) at work.

Get started now

The ideal time to start saving for your retirement is the day you draw your first paycheck. The next best time is right now, this very instant. The sooner you get started, the more potential doubling cycles your money can go through before you need to spend it to cover your costs. So, take the first step today, and set yourself up for a far better future than you otherwise would have had. The potential for $4,500 (or maybe even more) in tax savings is just icing on the cake.

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Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.