7 minute read
Saving for retirement is one of the most important financial goals, but did you know it can also be a powerful tool for reducing your tax bill? By maximizing contributions to retirement accounts like 401(k)s, traditional IRAs, SEP IRAs and others, you may be able to dramatically cut your taxes while building a substantial nest egg. In this post, we'll dive into the tax benefits of different retirement plans and show you how Corvee's tax planning software can help you and your clients take full advantage.
When you contribute pre-tax dollars to a retirement account, you're effectively reducing your taxable income for the year. Here's how it works:
Suppose you earn $100,000 and contribute $20,500 (the maximum in 2022) to your 401(k). That $20,500 comes right off the top of your income, so you're only taxed on the remaining $79,500. If you're in the 24% tax bracket, that could mean a federal tax savings of nearly $5,000 ($20,500 x 24% = $4,920).
The same principle applies to traditional IRA contributions, SEP IRA contributions, and contributions to other pre-tax retirement accounts. The more you can sock away now, the less you'll pay in taxes this year.
But the benefits don't stop there. The money in your retirement account grows tax-deferred, meaning you won't pay taxes on any investment gains until you withdraw the money in retirement. This allows your savings to compound much faster than if they were in a taxable account, where you'd have to pay taxes on gains each year.
Over time, this tax-deferred growth can make a massive difference in your retirement nest egg. Let's say you contribute $10,000 per year to a 401(k) for 30 years, and your investments earn an average annual return of 7%. After 30 years, your account would grow to over $1 million, even though you only contributed $300,000 out of pocket.
If you're 50 or older, you can put away even more in your 401(k) and IRA. These “catch-up” contributions allow you to save an additional $6,500 in your 401(k) and $1,000 in your IRA in 2022.
For someone in the 24% tax bracket, maxing out catch-up contributions could mean an additional tax savings of $1,800 or more. Over time, these extra contributions can supercharge your retirement savings while significantly reducing your tax bills.
Let's revisit our earlier example, but this time assume you're 50 years old and can make catch-up contributions. If you contribute $17,000 per year (the $10,000 from before plus $7,000 in catch-up contributions) for 15 years, earning that same 7% return, your account would grow to over $460,000 by age 65. That's nearly half a million dollars, even though you only contributed $255,000 out of pocket.
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Self-employed individuals and small business owners have even more options for tax-advantaged retirement savings, including:
Depending on your business structure and goals, one of these plans could offer significant tax savings and help you build substantial retirement wealth. For example, if you're self-employed and set up a Solo 401(k), you could potentially contribute up to $61,000 in 2022. If you're in the 32% tax bracket, that could translate to a tax savings of over $19,000.
While pre-tax retirement contributions offer immediate tax savings, Roth accounts like Roth 401(k)s and Roth IRAs have their own unique advantages. With a Roth, you contribute after-tax dollars, but your money grows tax-free and can be withdrawn tax-free in retirement.
Roth accounts can be especially beneficial if you expect to be in a higher tax bracket in retirement, as you'll avoid paying those higher rates on your withdrawals. They can also provide more flexibility, as you can withdraw your contributions (but not earnings) at any time without penalty.
Here's an example: Let's say you contribute $6,000 per year to a Roth IRA for 30 years, and your investments earn an average annual return of 7%. After 30 years, your account would grow to over $600,000. If this were a traditional IRA, you'd have to pay taxes on each withdrawal at your ordinary income tax rate. But with a Roth IRA, you can withdraw that entire $600,000 tax-free in retirement.
Corvee's Roth 401(k) and Roth IRA strategies can help you determine if a Roth account makes sense for your situation.
While the tax benefits of retirement contributions are clear, navigating the different plan types, contribution limits, and regulations can be complex. That's where Corvee's tax planning software comes in.
With Corvee, you can easily model different contribution scenarios to see how they impact your tax liability. The software's multi-entity tax planning capabilities allow you to see how changes to one entity's retirement contributions affect the overall tax picture, while the custom tax planning reports make it easy to present strategies to clients.
Plus, with over 1,500 tax-saving strategies at both the federal and state and local level, Corvee can help you identify additional opportunities to reduce taxes and maximize savings. Whether you're a CPA, financial advisor, or tax preparer, Corvee gives you the tools to provide comprehensive, proactive tax planning services.
Ready to unlock significant tax savings for yourself or your clients? Sign up for a Free Demo today and see how our powerful tax planning software can help you make the most of retirement account contributions and other tax-saving opportunities.
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