How To Utilize Tax-Deferred Accounts

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A tax-deferred account offers a tax-advantaged way to save for retirement. Although finding space in your budget to tuck funds away for the future is often challenging, the tax benefits might offer some enticement.

Explore how to use tax-deferred accounts below. Also, learn about other strategies you can use to minimize taxes on your retirement savings.

Understand Tax-Deferred Account Options

When you make a qualifying contribution to a tax-deferred account, the funds might be tax-deductible. For example, in most situations, if you contribute $6,000 to a traditional IRA, your taxable income will decrease by $6,000. For many taxpayers, this reduction in taxable income offers a worthwhile opportunity to decrease their tax bill.

If you are interested in taking advantage of these deductions, start by understanding the different tax-deferred account options. Some of the most popular tax-deferred account options include:

• 401(k): Employer-sponsored account; contributions are often deducted from your paycheck
• 403(b): Similar to a 401(k); accessible to employees of public school and eligible charities
• Traditional IRA: Individual account opened through a brokerage
• HSA: Health savings accounts available to those with high-deductible health insurance plans.

Depending on your situation, you might not have access to every account. For example, your employer might not offer a 401(k), which means that option is off the table for you.

Select the Accounts You Want To Use

Depending on your goals, you might opt to open just one or multiple tax-deferred accounts. For example, you might open a 401(k), traditional IRA and HSA to supercharge your retirement savings.

In some cases, you’ll open the account and make contributions through your employer. For example, 401(k) plans and 403(b) plans tend to be through an employer. But other types of accounts, like a traditional IRA, are things you can open on your own through a brokerage platform.

Make Your Contributions by the Deadline

Once you choose your accounts and open them, you’ll need to make your contributions by the deadline. The deadlines vary based on the account type.

In the case of your traditional IRA, you’ll have until tax day of the following year to finalize your contributions. For example, if you are catching up on your 2024 traditional IRA contributions, you can make those until April 15, 2025.

But in the case of your 401(k), Dec. 31 of the tax year is the final deadline to make contributions.

Although you can put off your contributions until the deadline, it’s usually a good idea to space out your contributions throughout the year. After all, it’s often easier to budget for ongoing contributions each month than dumping thousands into your portfolio at the deadline.

Report Your Contributions in Your Tax Return

When tax time rolls around, you should receive some documentation from your tax-deferred account provider that tallies up your contributions for the tax year. Don’t forget to include this documentation in your tax return.

Without the appropriate documentation, you cannot deduct your contributions from your taxable income for the year.

Avoid Touching the Funds Without a Qualifying Reason

Tax-deferred accounts are intended to help taxpayers save for significant expenses, like retirement and healthcare. With that, these accounts have rules on how and when you can spend the money. If you don’t have a qualifying reason to spend the funds, you might face a tax bill and penalty fees.

For example, if you withdraw funds from your traditional IRA before age 59.5, you’ll pay taxes on those funds on top of a 10% penalty. The 10% penalty might be waived if you have a qualifying reason, like disaster recovery costs or up to $10,000 for a first-time homebuyer down payment.

Since these costs add up, do your best to leave these funds untouched unless you absolutely need the money.

Takeaway

Tax-deferred accounts offer a worthwhile opportunity for taxpayers to build their savings on pre-tax dollars and potentially lower their tax bill. If you aren’t sure how you tap into these benefits in your situation, seek advice from a qualified tax professional.

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