Saving for retirement involves a lot more than just stockpiling cash under your mattress. Finding the right account to maximize your earnings in the future is a big deal, especially when you aren't going to see that money for decades. Choosing the right retirement account can mean saving on taxes right now.
Not all retirement accounts are created equal. Here are the ones that are tax-deductible.
Traditional IRA is tax deductible to a degree
A portion of your traditional IRA contributions can be deducted from your taxes, so make sure that you report them. If you are using a traditional IRA because you are self-employed or otherwise, this could make a dent in your taxes owed. It isn't a dollar-for-dollar deduction, but you will see your taxes shrink enough to make a difference.
The annual contribution limit for a traditional IRA in 2020 and 2021 is $6,000 if you are under the age of 50 or $7,000 if you are 50 or older. The number goes up slowly over time to align with inflation.
This option is good for people with lower incomes or those who only want to keep part of their retirement investments in an IRA. For example, you might want to diversify with an investment service or a robo-adviser, especially if you are curating your IRA portfolio yourself.
You can claim Solo 401(k) contributions, too
A solo 401(k) is also tax-deductible, and there are other benefits to using this account as well. For one, you can contribute as much as $57,000 for those under 50 or $63,500 for those 50 or over during the 2020 tax year.
Again, a portion of these contributions are tax-deductible, but it isn't dollar-for-dollar.
Simple IRA and SEP IRA
A simple IRA lets you contribute to your own retirement as well as up to 100 employees who make at least $5,000 from your business. Matching contributions are even eligible here. In addition to the IRA, there's also a simple 401(k) plan. Both of these are only deductible for those who are leading the plan (i.e a small business owner).
SEP IRAs are probably the most attractive for self-employed people because you can deduct a lot of contributions. This means the lesser of either 25 percent of your annual income or a maximum rate that's calculated by your personal cost of living.
Do 401(k) plans serve as a tax deduction?
Treasury Secretary Janet Yellen announced that she is looking into changes to current retirement plan rules. One of the changes many suspect the administration might propose is Biden’s plan, which is to replace the tax deduction for IRA and 401(k) contributions with a tax credit.— Christian (@EdenTax) March 3, 2021
401(k) plans aren't an overt tax deduction. However, those who contribute to a 401(k) plan aren't without their perks. These types of contributions can reduce your tax liability based on the number of times you contribute (for example, every two weeks from your regular paycheck).
Tax deductions are a gold mine, and if you can minimize the amount you owe the government each spring, why not take the opportunity? After all, the goal is to get to retirement, and deducting from your taxes owed makes that goal easier to attain.
Granted, this entire deduction process might change if the U.S. government moves forward with a tax credit process, but it's worth taking the steps to save now.