5 Tips How To Reduce Your Tax Bill By Saving For Retirement
Saving for retirement not only creates wealth for your future self, but it can also qualify you for tax breaks today. With the tax deadline extended until May 17, 2021 there is still some time to lower the amount of income tax owed this year. Here’s 5 tips on how to reduce your tax bill while creating a richer retirement for your future self.
1. Contribute to an IRA
According to the IRS, a contribution to a Traditional IRA reduces your taxable income by that amount, which in turn reduces the amount owed in taxes. The contribution limit for those under age 50 is $6,000, ($7,000 for those 50 years old and older). An individual in the 22% tax bracket can reduce their federal income tax bill by $1,320 by contributing the maximum amount to their IRA. You are able to contribute to your retirement account until the tax-filing deadline, so take the time to determine how much you can save on your taxes this year by adding funds to your IRA.
Another option to consider is opening a Roth IRA. With this type of retirement account, you will not have a tax break when you contribute to the account, but rather when you take a withdrawal. Earnings in your account grow tax-free and if you take a qualified distribution (when you are over 59 ½ and have had the Roth IRA for over 5 years), you can withdraw your Roth IRA funds tax-free.
2. Create a Spousal IRA
Although spouses cannot open a joint IRA, each individual can open their own account. By having two separate IRAs you can claim double the tax deduction. Couples can defer paying income tax on up to $12,000 ($6,000 contribution each), which can increase to $14,000 when each member of the couple turns over 50 years old. In addition, a working spouse can contribute on behalf of a spouse who does not earn any income.
3. Consider Using Your Tax Refund to Save for Retirement
If you obtained a tax refund, consider saving it in your retirement plan. Doing so can reduce next year's tax bill or even this year’s, depending on when the contribution is made. If you contribute between January and April, you will have to specify if you would like the amount to be applied to the previous tax year or the current calendar year.
4. Claim Saver's Credit, If Eligible
Those with a smaller salary and manage to save for retirement can claim a tax credit in addition to the tax deduction for making eligible contributions to your IRA or employer-sponsored retirement plan. Those who are eligible for saver’s credit in 2021 are those who contribute to their retirement savings and make less than $33,000 as an individual, $49,500 as head of household, or $66,000 as part of a married couple. The maximum credit is $1,000 ($2,000 if married filing jointly).
5. Qualified Charitable Distribution
When you reach age 72, you must take out Required Minimum Distributions from your retirement account. These required distributions count towards your earned income for the year and may even bump some individuals up into a higher tax bracket. Those who can afford to may donate the distribution to charity through a Qualified Charitable Distribution. In this case, the funds are transferred directly from your IRA to a qualified charity, thus avoiding paying taxes on the distribution.