American adults continue to worry about their retirement savings, especially as the cost of a secure retirement continues to rise. And well, they have their reasons for being so worried.
A recent study conducted by Northwestern Mutual (specialists in underwriting, permanent life insurance, disability income and long-term care insurance; annuities; investments, and more) reveals that Americans believe they need $1.46 billion to retire comfortably. This figure is 15% higher than that estimated in 2023.
Closing the Retirement Savings Gap: Effective Tax Strategies
An effective way to reduce the gap in savings is to minimize the tax burden both now and during retirement.
“When saving for retirement, taxes are a crucial factor that can drastically reduce your savings if not managed properly,” explains Andrew Gosselin, a certified public accountant in Princeton, New Jersey.
“With strategic planning, you can keep more of the money you’ve earned in your own pocket. Planning and being careful with taxes and savings protects what is yours.”
And the “magic trick” lies in starting early, the key decision that can change your life definitely during retirement. The sooner you start implementing tax strategies into your retirement savings plan, the better the outcome will be.
Here Are Some Ways to Reduce Your Tax Bill With Retirement Savings
Financial experts highlight the direct relationship between saving taxes and saving for retirement.
“Saving for retirement not only secures your future, but also offers tax benefits,” says Rozleen Giwani, a certified public accountant and partner at Grassi Advisors in New York. “By saving more of your current income, you can reduce your taxable income, which decreases your tax burden.”
Compound interest is a guarantee for the growth of your savings.
Also, starting saving early allows your funds to benefit from compound growth, amplifying your retirement fund over time. “It’s a win-win strategy for everyone, both in terms of financial security and tax efficiency,” says Giwani.
401(k) Plans Have Tax Advantages
When you contribute to a traditional 401(k) plan, the money is deducted from your salary before taxes are calculated. This means that you are reducing your current taxable income, which may result in a lower annual tax burden. For example, if you earn $50,000 a year and contribute $5,000 to your 401(k), you will only pay taxes on $45,000.
In both a traditional 401(k) and a traditional IRA, investments grow tax-free until you withdraw the money. This is known as tax-deferred growth. By not paying taxes on interest, dividends and capital gains annually, your money has more potential to grow.
Also remember that 401(k)s are plans that offer matching contributions from your employees, which means that the company you work for or your boss will contribute an additional amount of money to your account. In many cases, a percentage of your contributions is matched.
Roth 401(k) and Roth IRA: Do They Have Tax Advantages?
With a Roth 401(k) or Roth IRA, you contribute after-tax money, which means you don’t reduce your current taxable income. However, the earnings in your account grow tax-free and withdrawals during retirement are tax-free if you meet the requirements. This can be advantageous if you expect to be on a higher tax rate in the future.
Contributions to a traditional IRA may be tax-deductible, depending on your income and whether you or your spouse are covered by a retirement plan at work. This deduction can reduce your taxable income and, consequently, your tax bill.
Small businesses can reduce their taxes with deductions for retirement plans
If you own a small business, you can set up retirement plans for yourself and your employees that also offer tax benefits. SEP IRA and SIMPLE IRA plans are popular options that allow tax deductions for contributions.
Among the most popular options for small businesses are the SEP IRA and SIMPLE IRA plans.
A SEP IRA is a simplified pension plan that allows small business owners and their employees to save for retirement with tax-deductible contributions. This type of plan is ideal for companies with few employees due to its simplicity and flexibility.
Employers can decide how much to contribute each year, which is useful if the company’s income varies. Contributions can be up to 25% of the employee’s salary or up to a specific limit set by the IRS.
The SIMPLE IRA is another viable option for small businesses, specifically designed to make it easier for employees to participate in saving for retirement. These types of plans offer small businesses to make contributions for 3% of the employee’s salary, or non-elective contributions of 2% of each qualifying employee’s salary.
These contributions are tax-deductible, which again reduces the taxable income of the company. Employees can make SIMPLE IRA contributions, which are also tax-deductible, helping to increase their retirement savings.
