Tax Advantages of Maximizing Retirement Fund Contributions

June 18, 2020 by Karen Thomas-Brandt, EA
401k binder on desk

Every year around tax time, I hear the same question: What can I do so I don’t owe so much tax next year? While there are several ways to save on your tax bill, one of the easiest ways is to put money away for retirement.

These days, taxpayers have many options for retirement savings: Traditional IRA, Roth IRA, 401k, Roth 401k, SEP IRA, 457b, SIMPLE IRA – just to name a few. The ones that will help you with your tax bill now are those that allow pre-tax contributions, such as a 401k and Traditional IRA. Making pre-tax contributions means that you won’t pay tax on that money now (taxes will be deferred until you make withdrawals during retirement), which means a lower taxable income. Having a lower taxable income means less tax due, possibly even a lower tax bracket, and even a potential increase in tax credits.

Let’s take, for example, Bob, age 35, a single taxpayer with a child, age 9. Bob has a good job, and his W2 shows $230,000 in wages for 2019. If Bob makes no contributions to his employer’s 401k plan, and assuming he takes the standard deduction for a Head of Household individual ($18,350 for 2019), he will have a taxable income of $211,650 and a tax liability of $47,853, putting him in the 35% tax bracket. Additionally, Bob will be entitled to $500 of the child tax credit.

However, if Bob maximizes his 401k contribution ($19,000 for 2019), his W2 income would then show $211,000 in wages. After his standard deduction, Bob’s taxable income would be $192,650, with a tax liability of $41,546, putting him in the 32% tax bracket. Also, Bob would now be entitled to $1450 in child tax credit.

As you can see, by maximizing his retirement fund contribution for 2019, Bob will decrease his taxable income by $19,000, move to a lower tax bracket, and increase his child tax credit by $950. Even better, Bob is now well on his way to saving for retirement!

Tags: 401k, retirement

SEARCH

 

Karen Thomas-Brandt, EA
Corporate Trainer

 

Karen Thomas-Brandt, EA, is a Corporate Trainer at TaxAudit, the largest and fastest-growing audit defense service in the country and the exclusive provider of TurboTax® Audit Defense. With more than 16 years in the tax field, Karen has prepared thousands of tax returns and defended hundreds of taxpayers in audits. In her current role, Karen specializes in researching complicated tax topics, developing workshops, and training tax professionals on effective audit representation and tax return analysis.


 

Recent Articles

Tax Deadline written on July 15th
With the July 15th tax deadline approaching, here’s what you need to know. (1) If You Need More Time, You Can Still File for an Extension (2) Pay What You Owe
House prices going up
The reality is you can sell your house to your child, grandchild, or anyone else for that matter, for $1. But just because you can doesn’t mean you should.
Garnishment of Wages written on a notepad
Yes, it is possible to make a deal to keep the IRS from garnishing your paycheck. Making payment arrangements with the IRS maybe all that is needed.
Audit Defense Tax Professional
Audit defense gets you access to a dedicated tax professional who will develop a strategy and handle all communications with the IRS or state agency.
This blog does not provide legal, financial, accounting, or tax advice. The content on this blog is “as is” and carries no warranties. TaxAudit does not warrant or guarantee the accuracy, reliability, and completeness of the content of this blog. Content may become out of date as tax laws change. TaxAudit may, but has no obligation to monitor or respond to comments.