Most people know they should be saving for retirement, but it's often difficult to delay more immediate needs. To sweeten the deal, the federal government and many employers provide additional incentives to save for the future. Taking advantage of these retirement savings perks will help you to build wealth faster.
Tax breaks. The federal government provides a variety of tax breaks to encourage workers to save for retirement. Workers are eligible to defer paying income tax on up to $18,000 they depot in a traditional 401(k) and as much as $5,500 in a traditional IRA. Maxing out both of these accounts would reduce your tax bill by $5,875 if you are in the 25 percent tax bracket. And workers age 50 and older can defer income tax on an additional $1,000 in an IRA and $6,000 in a 401(k). Income tax won't be due on this money until it is withdrawn from the account, and if you withdraw the money in a year when you are in a lower tax bracket you will reduce your lifetime tax bill.
Alternatively, you could contribute after-tax dollars to a Roth 401(k) or Roth IRA and set yourself up with tax-free distributions in retirement. If you withdraw the money from the account after age 59 ½ from an account at least 5 years old you won't ever have to pay tax on the investment gains. Roth accounts can be an especially good deal for young people who have a long time for their money to grow as well as those paying a low tax rate in the year they make the contribution.
If you contribute to any of these retirement accounts while earning less than $30,750 for individuals and $61,500 for couples, you may additionally qualify for the saver's credit. This tax credit it worth between 10 and 50 percent of your retirement account contributions up to $2,000 for individuals and $4,000 for couples. For example, a married couple with a joint income of $30,000 who saves $1,000 in a 401(k) plan could earn a $500 tax credit. This tax credit can be claimed in addition to the tax deduction on the same retirement account contribution. So, the couple will also get a tax deduction of $150, assuming they are in the 15 percent tax bracket. If they claim both the tax deduction and credit, that $1,000 401(k) contribution effectively only cost them $350.
Employer contributions. Company contributions to retirement accounts are the fastest way to build wealth for retirement. If an employer provides 50 cents for each dollar you contribute to the 401(k) plan, that's a 50 percent return on your investment. A worker earning $50,000 per year who earns a 50 percent 401(k) match on up to 6 percent of pay could gain an additional $1,500 in employer contributions. Some firms even provide a dollar-for-dollar match, which is effectively doubling your money.
However, you don't always get to keep the 401(k) match unless you work for the employer that made the contributions for a specific number of years. Many companies have vesting schedules that require that you stay with the firm for several years before you can take a portion or all of the company contributions with you when you leave. But you always get to keep your personal contributions to the account, so there isn't much to lose by saving in the 401(k) plan just in case you stay at the job long enough to get the match.
Investment growth. The earlier you start saving for retirement, the more work compound interest can do on your behalf. If you save $5,000 per year beginning at age 30 and earn a 5 percent annual return, you will have $463,745 at age 65, even though you only personally contributed $175,000 to the account. If you wait until age 40 to start saving $5,000 per year and earn the same return, you will only have $245,052 upon retirement. You would need to save around $9,500 per year beginning at age 40 to end up with $465,598 at age 65. Beginning to save in your 20s or 30s allows the investment returns to accumulate in the account and makes it easier to build a large nest egg for retirement.
Emily Brandon is the author of "Pensionless: The 10-Step Solution for a Stress-Free Retirement."
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