How Maximizing Retirement Contributions Can Save You in Taxes in 2024
Written by
John Csiszar
Edited by
Gary Dudak
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As we head into 2024, it’s a good time to review your retirement saving strategy. In addition to evaluating your investments — and bumping up your contribution rate — it’s important to think of the role your retirement contributions play in your tax saving strategy.
Along with providing long-term, tax-deferred growth, most retirement accounts also offer current tax savings. Here’s a look at the ways that maximizing retirement contributions can save you in taxes in 2024.
Reducing Your Taxable Income
One of the primary benefits of investing in a 401(k) plan is that you don’t have to pay taxes on the amount you contribute. Any contributions you make are subtracted from your paycheck and are not considered taxable income. This reduces the amount of tax that your employer will take out of your monthly paycheck. The more you contribute, the less tax you’ll have to pay.
Imagine, for example, that you earn $4,000 per month in gross income but want to contribute 10% of your income to your 401(k) plan. That $400 per month will get deducted from your paycheck and you’ll receive just $3,600 in taxable income. If you keep those contributions up over the course of the year, you’ll end up reducing your annual taxable income by $4,800.
Providing Tax Deduction
Many Americans don’t have access to a 401(k) plan, but they can still take advantage of tax benefits from accounts like IRAs. Although both IRAs and 401(k) plans offer tax breaks on contributions, they operate in a slightly different fashion. Whereas a 401(k) contribution reduces your taxable income at the time they are made, IRAs provide a tax deduction at the time you file your tax return.
Here’s how it works. Let’s say you earn $4,000 per month in gross income, same as above, and you want to contribute the same 10% of your salary to your IRA. You can contribute $400 per month to your IRA — or $4,800 in a lump sum, if you so desire — and then claim that deduction on line 20 of Schedule 1 of your Form 1040. If you’re self-employed and are using a SIMPLE IRA, you’ll claim your deduction on line 16 of Schedule 1.
Ultimately, your IRA deduction will be taken off your taxable income as you complete Form 1040. In that sense, your IRA contribution lowers the amount you’ll pay in taxes just like a 401(k) contribution does, although the process is a bit different.
Eliminating Annual Investment Taxes
All qualified retirement plans, including IRAs and 401(k) plans, offer tax-deferred growth. What this means is you won’t pay tax every year on your investment gains, whether they come from dividends, interest, or realized profits on any sales. Rather, those gains are deferred until you withdraw money from the account, typically in retirement. This can both supercharge the compound growth of your investments and also lower the amount you have to pay in tax every year.
For example, imagine you have a $100,000 retirement portfolio earning 4% in dividends and interest every year. That amounts to $4,000 in annual income. If you earned that money in a taxable investment account instead, you’d be on the hook for anywhere from a few hundred to a few thousand dollars of tax every year. Your retirement account, however, shields you from those taxes until you take the money out.
How Much Can You Contribute in 2024?
To get the greatest tax benefit possible, you’ll have to contribute the limit allowable by the IRS. This amount varies depending on the type of plan you’re contributing to, and it can also change from year to year. For example, here’s a look at the maximum contribution limits for IRAs and 401(k) plans for both 2023 and 2024:
- 401(k) plans: $22,500 in 2023, $23,000 in 2024
- Traditional IRAs: $6,500 in 2023, $7,000 in 2024
- SEP-IRAs: lesser of 25% of compensation or $66,000 in 2023 and $69,000 in 2024
- SIMPLE IRAs: $15,500 in 2023, $16,000 in 2024
These are the maximum amounts that most people can contribute to these types of plan to garner the highest possible tax benefit. However, if you are age 50 or older, the IRS allows “catch-up” contributions, beefing up the total maximum contribution level. Here are the catch-up contribution amounts for 2023 and 2024:
- 401(k) plans: $7,500
- Traditional IRAs: $1,000
- SEP-IRAs: $1,000
- SIMPLE IRAs: $3,500
What this means is that if you are at least 50 years old and contributing to a 401(k) plan, you can sock away a whopping $30,500 in 2024, assuming you have that much in earned compensation. That could amount to a savings of thousands of dollars on taxes annually, and over $10,000 for those in the top tax brackets.
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