Tax Tips
Trim Taxes by Boosting
Retirement Savings
Max out your contributions while you can; limits won’t increase in 2010.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
November 19, 2009
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Despite a remarkable rebound in the stock market since last March, your 401(k) balance may still be a mere shadow of its former self. And it’s not just the colossal market crash that’s to blame. Overall, the past decade has been a real disappointment for investors. One of the best ways to fatten your nest egg while trimming your taxes is to max out your contributions to your retirement plan.
This year, you can contribute up to $16,500 to your 401(k) or other tax-deferred retirement accounts, such as a 403(b) for teachers and nurses, or a 457 plan for police officers and other local-government workers. That's $1,000 more than the 2008 limit. If you're 50 or older, you are allowed to put in an extra $5,500 in catch-up contributions, sheltering up to $22,000 of your salary from federal and state taxes this year (although you'll still be nicked for FICA taxes).
Tell your employer to adjust your remaining paychecks to boost your contribution if necessary. Or if you receive a year-end bonus (remember those?), ask whether you can defer some or all of it to your retirement account.
If you are self-employed or have a sideline business, you can stash away even more. And if you can’t come up with the cash just yet, don't worry. You won't have to fund your business retirement account until you file your tax return next spring.
If you are self-employed with no employees (other than your spouse), you can open a solo 401(k) plan and contribute up to $16,500, plus your business can kick in an additional 20% of your net self-employment income until the total pay-in for 2009 reaches $49,000. If you're 50 or older, you can fund an extra $5,500 in catch-up contributions for a total of $54,500 this year.
If you have a sideline business in addition to a job as an employee with a company 401(k), you can't double up on your 401(k) contributions. The same annual limit of $16,500 (plus $5,500 in catch-up contributions if you're 50 or older) applies whether you have one job or more. But you can contribute to a SEP IRA, stashing away up to 20% of your net self-employment income up to a maximum of $49,000 for 2009. SEP IRAs have no catch-up provisions for those 50 and older.
Reader Comments (4)
Posted by: Ari at 11/19/2009 08:59:42 AM
Just remember that the "tax savings" proposed in the title of this article are not in your hand - those tax dollars are simply in your retirement plan. In light of all the budgetary issues that the US is facing right now, we are all very likely going to be paying far higher taxes down the road. Is it really so brilliant to then defer earnings to a higher tax bracket down the road and enjoy the smooth ride of the stock market along the way?
Posted by: Bob at 11/20/2009 10:36:26 AM
As this article suggests, I maxxed my 401K contributions for several years before retirement but am now faced with the quandary over converting to Roth IRAs or dragging out the (likely higher) deferred taxes for years to come as I take distributions. While the old theory was that after retirement my income would be less and I would be in a lower tax bracket, that does not seem to be case. Even if I split it up for years to convert to Roths, my yearly taxable income during retirement will actually be higher(not lower) than any previous year that I did work. At least back then I had the kids and other deductions which I no longer have. Now with the prospect that taxes at all levels will be escalating in the near future, the tax deferred 401K doesn't look so great unless that is your only option and your employer matches contributions. Now, the pay taxes as you go Roth looks better. You may not put away as much each year but at least you will have minimized the unknown of future tax rates.
Posted by: Arthurine Pierson at 11/24/2009 10:14:23 AM
This information may be informative to some but it is general knowledge. I read articles about contributions to save taxes and how to convert money to Roth after 2010. However, I need some information on how to make contributions now in preparation for converting to Roth next year. Seems there is a gap in connecting the two pieces of information. How does the contributions for tax purposes change with all the changes in 2010 and 2011+ tax laws? Hopefully, you will read this comment and write an additional article. This comment will be quite long because going further to try to get my specific questions answered. In the past pre-TIRPA, I operated under 1) Max out the contribution to your 401K to match only your employer's contribution portion (Not max out the contribution limits) 2) Max out your and your spouses's dedictable IRA if under income caps; skip the non-deductible IRA option. 3) Put the rest in taxable accounts with tax rates of 15% or lower based on income. However after TIRPA, I would like to know how to operate now in 2009. (I'm and my wife 56, both retiring next year, and make over $150K with dual pensions and should just go up if we tap our retirement accounts) 1) Max out the contribution to your 401K including pre-tax limits (over 50 22,000 for example) plus for highly compensated employee max out the total after-tax contribution (49,500?), also. You can roll this contribution over to an ROTH IRA without any further taxes at retirement. (If you do not have it stuffed in an IRA, you can no longer contribute without earned income) 2) Max out your IRA (over 50 6,000) in either a deductible or non-deductible IRA depending on your income. Same as above, if you do not have it stuffed in an IRA, you can no longer contribute without earned income. 3) Put the rest in taxable accounts with tax rates of 20%. Since income bracket rates are rising, get as much as you can in ROTHs in 2010+. Is there a nice strategy to roll over to Roth? How does the IRA accounts work with the 401K when counting that percentage to pay taxes? It gets really complicated since my wife also has a 401K and IRAs.
Posted by: Lyndon at 11/29/2009 04:56:23 AM
I would like to comment on Arthurine's post. First, congradulations on your success and forthcoming retirement. Second, I'd like to defend Mary Beth's article by saying her article was directed at a large target audience that can relate and/or use the information she conveyed. Your situation, without a doubt, is unique and does not fit the scope of her intended audience. I would venture to say that most readers would love to have your financial posture. Third, I don't think this is a proper forum for you to air-out all your finances for the world to see (I live in Belgium) with respect to your specific question. Lastly, I hope that a consultant has or will address your question due to your post.