There are plenty of smart tax moves you can make in 2017. Saving receipts every time you donate money to a charitable organization, maximizing your education tax breaks, or buying your first house could all put more money back in your pocket at tax time next year, just to name a few.
However, I'd have to say that increasing your retirement savings is the smartest tax move of all. Not only can you get a nice tax break for your contributions to an IRA, 401(k), or other retirement plan, but by taking advantage of this, you'll also be building up a nest egg, and getting closer to financial freedom later in life.
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3 potential tax benefits of tax-deferred retirement savings
When you save and invest in a tax-deferred retirement account, such as a traditional IRA or in a 401(k) at work, there are three potential tax benefits.
1. Your contributions can be tax-deductible
The first benefit is the most immediately obvious. When you contribute money to a qualified tax-deferred retirement account, your contributions could be deductible from your income.
With a traditional IRA, Americans who qualify can contribute and deduct $5,500 to a traditional IRA for the 2017 tax year. If you're 50 or over, this limit jumps to $6,500. If you and your spouse don't have a retirement plan at work, you're automatically eligible to deduct your traditional IRA contributions. If you do have a retirement plan at work, higher-income individuals aren't allowed to take the deduction. Here are the limits for 2017, so you can determine whether or not you qualify.
In a 401(k), or other employer-sponsored retirement plan, the limit on elective deferrals (money from your salary that you choose to contribute) is $18,000, or $24,000 if you're 50 or older. These contributions reduce your income and are typically reflected in your gross wages listed on your W-2.
Depending on how much you contribute, this can be a pretty big tax break. For example, if you contribute $10,000 between an IRA and 401(k) this year, it could knock $2,500 off of your tax bill if you're in the 25% bracket.
2. You could get the Saver's Credit
In addition to the tax deduction, lower-income taxpayers may also qualify for the Retirement Savings Contributions Credit, also known as the Saver's Credit. This is designed to motivate lower-income households to save for their retirement, and can be worth up to $1,000 per year, per person.
Specifically, the credit is worth up to 50% of the first $2,000 in contributions to qualified retirement accounts. To qualify, married couples must have adjusted gross income (AGI) of $62,000 or less, and single filers can have AGI of up to $31,000. Here's the full details on the income limits and credit percentages:
Married Filing Jointly
Head of Household
Single and Others
AGI of $37,000 or less
AGI of $27,750 or less
AGI of $18,500 or less
Data Source: IRS.
3. Your investments can grow faster
Finally, and in my mind the most compelling, reason to increase your contributions to tax-deferred accounts is that they allow your retirement nest egg to grow faster than it would in a standard (taxable) investment account.
In a tax-deferred account, you don't have to pay any tax on the dividends your investments generate. Instead, when you receive a dividend payment, 100% of it can be reinvested. The same can be said for capital gains -- when you sell an investment at a gain in your traditional IRA, you aren't expected to pay tax on the profit. You can use the entire amount of the sale to invest in something else.
Over time, this can make a big difference. Here's a calculator that can help you estimate the long-term potential of your tax-deferred retirement savings.
* Calculator is for estimation purposes only, and is not financial planning or advice. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional.
Now, it's important to mention that this calculator makes certain assumptions. For example, it assumes you'll pay taxes on your gains every year, which isn't usually the case, unless you're a very active trader. Furthermore, long-term capital gains and most dividends are taxed at a more favorable rate than your marginal tax bracket.
Even so, the point is that without having to worry about taxes, you're your retirement nest egg has some serious growth potential over long periods of time.
It's also important to mention that Roth IRAs are another fantastic option, but don't offer the same tax benefits. You can read more about Roth IRAs here, but in a nutshell, you don't get a tax deduction now, but your eventual withdrawals in retirement will be tax free. Roth IRAs have other benefits as well, so take a moment to compare the two to see which is the better fit for you.
The bottom line is that there are several compelling reasons to boost your retirement savings in 2017. Your money will never have more long-term compounding power than it does right now, so take advantage of tax-deferred savings to increase your tax refunds and grow your nest egg faster.
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