Tax Tips
Trim Taxes by Boosting Retirement Savings
Max out your contributions while you can and prepare to save a bit more next year.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
November 22, 2011
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There’s still time to trim your 2011 income tax bill and boost your retirement savings at the same time.
SEE ALSO: 12 Year-End Tax Moves to Make Now
You have until December 31 to contribute up to $16,500 to your 401(k) or to another tax-deferred retirement account, such as a 403(b) for teachers and nurses, a 457 plan for police officers and other local-government workers, or the Thrift Savings Plan for federal workers and military personnel. That's the same maximum contribution level as last year; next year the maximum retirement-plan contribution increases to $17,000.
At the very least, try to contribute enough to capture all of your employer’s matching contribution. Otherwise, once the year ends, those unclaimed dollars are gone forever.
If you're 50 or older, you are allowed to put in an extra $5,500 in catch-up contributions in your workplace-based retirement plan, sheltering up to $22,000 of your salary from federal and state taxes in 2011 (although you'll still be nicked for payroll taxes that fund Social Security and Medicare).
Tell your employer to adjust your remaining paychecks to boost your contribution, if necessary. And if you receive a year-end bonus, ask whether you can defer some or all of it to your retirement account.
Low-income workers and those who work part-time or intermittently -- perhaps you landed a new job partway through the year after months of unemployment -- have an added incentive to feed their retirement account. In addition to the usual tax breaks, you may qualify for the retirement saver’s tax credit, which can be worth up to $1,000 (tax credits reduce your tax bill dollar-for-dollar).
To qualify for the credit, your income can’t exceed $27,750 if you are single; $41,625 if you’re the head of a household with dependents; or $55,500 if you’re married filing jointly. In addition, you must be at least 18 years old by the end of the year, you cannot be a full-time student and you can’t be claimed as a dependent on another person’s tax return. The retirement saver’s credit ranges from 10% to 50% of your first $2,000 of retirement contributions. The lower your income, the bigger the credit. Learn more about more Tax Breaks for the Middle Class in our slide show.
Extra help for the self-employed
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). You can contribute up to $16,500 to your plan (but not more than your earnings), and your business can kick in an additional 20% of your net self-employment income (that’s your gross self-employment income minus half of your self-employment tax) until the total pay-in for 2011 reaches $49,000.
If you're 50 or older, you can put in an extra $5,500 in catch-up contributions, for a total of $54,500 this year. Although you don’t have to fund the account until you file your tax return next spring (or by October 15, 2012 if you file for an extension), you have to establish a solo 401(k) plan before the end of this year in order to deduct the contribution from on your 2011 tax return.
If you have a sideline business in addition to a job as an employee with a company that offers a 401(k) plan, you can't double up on your 401(k) contributions. The same annual employee 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. However, 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 2011 (SEP IRAs have no catch-up provisions for those 50 and older).
What’s more, you can set up and fund your SEP IRA as late as April 16, 2012 (April 15 is a Sunday), and still exclude your contribution on your 2011 tax return. And if you file for an extension, you can delay your set-up and funding date until October 15, 2012.
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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.