As interesting as your job may be, you might not want to work at it forever. And if you save money now, it will help you meet your financial needs when you retire.
Social Security may provide you with some funds, but it was never designed to be a person's sole source of retirement money. If you want to travel instead of watching travel shows on television, you'll probably want to supplement Social Security with your own savings.
To help you accumulate money for the things you will want to do in retirement, the government offers some tax breaks when you save money now within certain types of tax-qualified retirement accounts. This article will give you an overview of the different plans so that you know where to do further research.
Individual Retirement Accounts
People saving for retirement on their own or looking to supplement an employer's plan can do so through an Individual Retirement Account (IRA). Let's take a look at Traditional IRAs and Roth IRAs.
The amount of your annual contribution to a Traditional IRA that can be deducted from your federal income taxes is dependent on two factors.
- Whether or not you or your spouse participates in an employer-sponsored retirement plan.
- The amount of your modified adjusted gross income as determined on your federal income tax return.
The 2022 and 2023 IRA rules are a good thing to know and understand. The following scenarios should help you determine whether or not your contributions are deductible.
- If you (and your spouse) are not covered by an employer sponsored retirement plan, your contributions to a Traditional IRA are fully federally income tax deductible, regardless of the amount of your modified adjusted gross income.
- If you (or your spouse) are covered by an employer sponsored retirement plan, your modified adjusted gross income level will determine how much of your contribution is federally income tax deductible.
Allowed deduction, depending on filing status and modified adjusted gross income
The amount you may deduct, whether a full deduction or partial, depends on your tax filing status. Follow this link to find the amounts for Traditional IRAs; they are located in the Modified Adjusted Gross Income section. The following link provides Roth IRA Eligibility Requirement information that is under the Eligibility Requirements for Roth IRA Contribution section.
If you are married and you and your spouse file a joint income tax return, and you are not an active participant in an employer-sponsored retirement plan, but your spouse is, deductibility of your Traditional IRA contributions is dependent upon your combined modified adjusted gross income as described below.
Allowed deduction, depending on combined modified adjusted gross income
If you aren't covered by a retirement plan at work but your spouse is, this information provides the full and partial amounts.
- Traditional IRA - select the Modified Adjusted Gross Income section and look for Combined Modified Adjusted Gross Income.
- Roth IRA - select the Annual Contribution Limits.
Traditional IRA plans
With a Traditional IRA plan, the money you contribute may be deductible from your federal income taxes now. There's no tax due on the interest, dividends and capital gains earned while you hold the account, either. You will generally have to pay income taxes on withdrawals, but many people find themselves in a lower tax bracket when they are retired than when they are working. Before you turn 59½, your withdrawals will generally be subject to a 10% penalty tax unless they meet certain exceptions for such things as qualified medical, educational and first-time home buyer expenses.
Roth IRA plans
Roth IRA plans are named for their champion, the late Senator William Roth of Delaware. Contributions to these accounts are not federally income tax deductible. However, the funds you contribute, and the earnings on them, are generally not taxed when a withdrawal is made, as long as you've owned the account for at least five years and reached the age of 59½.
Younger workers can withdraw the amount they put in at any time, but if they want to withdraw earnings for anything other than the standard exceptions, they will pay a federal income tax on any income or capital gains earned, as well as a 10% penalty tax.
Traditional IRA plans vs Roth IRA plans
|Traditional IRA||Roth IRA|
|Are contributions tax deductible?||Contributions may be deductible on your federal income tax return.||Contributions are not tax-deductible on your federal return, but can be withdrawn anytime, tax-free.|
|Are there contribution income limits?||There are no income limits for contributions, but there are income limits on deductions.||Contributions are subject to income limitations.|
|Are earnings exempt from taxes?||Earnings are exempt from federal income tax return until withdrawn.||Earnings are tax-free for qualified distributions.|
|Are withdrawals mandatory?||Withdraws are at age 73. Your first Required Minimum Distribution must be taken by April 1 of the year following the year you reach age 73.||No mandatory withdrawals at any age (until after the death of the owner).|
Source: Retirement Plans FAQs regarding Required Minimum Distributions | Internal Revenue Service (irs.gov)
Source: IRA Rules: Your 2022 and 2023 Cheat Sheet - NerdWallet
Employer retirement plans
Employers can offer retirement plans to help attract and retain good employees. Retirement plans can help employers save money at tax time. Some types of plans allow them to offer additional tax breaks to employees as well.
In the past, many employers offered a pension, which provided a steady income after retirement. Fewer employers do that these days, instead favoring SIMPLE IRAs, SEP IRAs or 401k plans (offered to employees of for-profit businesses). In a SEP IRA, the employer makes all contributions to the plan. Under the other plans, the employer may make a non-elective contribution for all employees, or it may offer to match a percentage of the funds that employees contribute.