What if you could boost your retirement savings, courtesy of Uncle Sam? Some of the most generous provisions of the tax code are incentives to save whether via a workplace 401(k), an Individual Retirement Account, a Roth IRA, or one of many retirement plans for the self-employed. Yet year after year taxpayers fail to take advantage or make costly mistakes.
Here are some tricks to make the most of the breaks, and traps to watch out for, courtesy of David Prokupek, chief executive officer of the Jackson Hewitt tax prep chain. “A lot of people like handholding, especially around retirement; it’s a lot of math,” he says.
Why worry about retirement at tax time? You can fund an IRA for 2014 until April 15th and a SEP-IRA (for the self-employed) until Oct. 15th—the due date of your 1040 with extensions. And it’s a good time to review your 401(k) workplace retirement contribution choices for 2015 to make sure you’re saving enough to grab any employer matching money and to consider making extra catch-up contributions if you’re 50 or older.
Think you don’t have enough money to save for retirement? If you’re strapped for savings, don’t let the maximum contribution levels ($18,000 for a 401(k), $5,500 for an IRA, plus $6,000 and $1,000 catch-ups respectively) intimidate you. Instead calculate what a $2,000 contribution, for example, will really cost you. It’s not entirely obvious you might save $800 on your taxes (assuming a 40% combined federal and state rate), says Prokupek. Saving for retirement starts to become more affordable and understandable when you run your return—with and without the retirement contributions. Once you calculate what the tax break would mean, then you can consider Roth accounts which don’t get you an upfront break but grow tax-free and distributions come out tax-free.
Can you snag the saver’s credit? One of the biggest overlooked credits is the saver’s credit, which gives low-to-moderate income taxpayers with adjusted gross income of up to $60,000 a tax credit of up to $1,000 for saving in a retirement plan per person. “Most people don’t know it exists,” Prokupek says. Forbes contributor Walter Updegrave has details here.
Scour your taxes for savings and funnel that money back into retirement. Taxpayers often miss deductions and credits based on life changes, Prokupek says. Find one, and it’s like free money; steer it towards retirement savings. Common examples: a newly single mom who can file as head of household (a higher standard deduction and lower marginal rate applies); and couples with children under 13 (or elderly dependents) who miss the child and dependent care tax credit.
Did you get a 1099? A lot of people are being moved from salary-based employees who get W-2s to independent contractors or freelancers who get 1099s. They can benefit from retirement plans geared towards the self-employed: a SIMPLE IRA, SEP-IRA, a solo 401(k). “There are a lot more ways to put money away and in higher dollar amounts,” Prokupek says. “It’s tricky.” If you have solo income, check out Two Jobs, Two Retirement Plans, for help.
Thinking of taking money out early? One of the biggest mistakes is withdrawing money before retirement age. You’ll usually owe a 10% penalty plus taxes. “That’s a double penalty,” Prokupek says. Internal Revenue Service statistics show that 689,504 taxpayers paid early retirement withdrawal penalties in 2013. One exception is a Roth IRA: you can take out your contributions tax-free and penalty-free at any time. Alternatives: borrow from your 401(k) or take out a second mortgage.
Thinking of cashing out? If you’ve switched jobs, don’t take the money out of your old 401(k). “We see a lot of low balances, and we try to remind people to roll it over into a new employer plan or into an IRA,” Prokupek says. If you leave a small balance 401(k) account behind, your ex-employer could move it into a forced IRA, which could end up depleting the account.
Help your kids start saving for retirement. Business owners can employ their children and start them on an early road to retirement savings by helping them set up an IRA for their earnings. “It’s often overlooked,” Prokupek says. Another approach is to match money your child makes on their own from a summer job—they keep their pocket money and fund an IRA with your gift.
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