Savings

This retirement savings tip could save you a ton on your taxes this year

Tax season is here, and if you’re like most people, you’d like to keep as much of your 2021 income as possible. One way to do that is to make sure you claim all the tax credits and deductions that you you are entitled.

Although it’s 2022 now, there are still some last-minute tax breaks you can take advantage of if you want to lower your tax bill a bit. Here’s one worth considering if you have a little extra cash on hand.

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How saving for your future can lead to savings today

Investing in a retirement account can help you build the nest egg you’ll need to help cover future expenses, but if you use a tax-deferred retirement account, there’s an immediate benefit too.

Contributions to the tax-deferred retirement account reduce your taxable income for the year. This means that if you put $5,000 into a traditional IRA right now for the 2021 tax year, you reduce your 2021 taxable income by $5,000.

This can result in a lower tax burden and possibly a larger refund, especially if your pension contribution puts you in a lower tax bracket. If this happens, you’ll pay a smaller percentage of your income to the government, which means you’ll have more money left in your pocket.

There is an additional bonus for low income savers

Hiding money in a retirement account can also make you eligible for the saver’s tax credit. This could be worth up to 50% of your pension contribution, with a maximum contribution of $2,000. This means that if you qualify for the 50% credit and contribute $2,000 to a retirement account for 2021, you could reduce your 2021 tax bill by $1,000.

This is different from a deduction, which reduces your taxable income. A $1,000 tax credit essentially means you owe the government $1,000 less than you would otherwise. This can have a significant effect on your refund amount.

To qualify for this credit, you must be 18 or older and not be claimed as a dependent on someone else’s tax return. You can’t be a student either.

The amount of credit you get depends partly on the amount of your contribution, but also on your adjusted gross income (AGI) and your tax filing status for the year. This chart shows how much you’ll get if you claim this credit on your 2021 taxes.

Credit rate

Married Filing Jointly

head of household

All other registrants

50% of your contribution

AGI no more than $39,500

AGI no more than $29,625

AGI no more than $19,750

20% of your contribution

$39,501 to $43,000

$29,626 to $32,250

$19,751 to $21,500

10% of your contribution

$43,001 to $66,000

$32,251 to $49,500

$21,501 to $33,000

0% of your contribution

AGI over $66,000

AGI over $49,500

AGI over $33,000

Data source: IRS.

So if you are a single filer, you can only take advantage of this credit if your AGI is less than $33,000. Individuals with higher AGIs will still benefit from the tax deduction mentioned above, but they are not eligible for the saver’s credit.

How to start

If you have a little extra cash and think a tax-deferred pension contribution is right for you, there’s no time to waste. A traditional IRA is probably your best bet because you can make prior year contributions to these accounts until the tax deadline for the year, while 401(k)s don’t allow contributions. of the previous year.

Open an IRA with any broker that interests you and deposit funds into the account. Keep in mind the annual contribution limits. You can only contribute up to $6,000 to an IRA for 2021 or $7,000 if you’re 50 or older.

Since you are making a contribution from the previous year, you may also need to contact your account provider to ensure that they are applying your contribution to the correct year. Otherwise, they may default to a current year contribution, which will not help you with your taxes at this time.

Be sure to do all of this before you file your taxes. If you wait until later, you will need to submit an amended tax return to claim your credit. And no one wants to do their taxes twice.

One last thing: tax-deferred pension contributions are not the best choice for everyone. If you think you’re in the same or lower tax bracket than you’ll be in when you retire, a Roth account might be better for you in the long run. But since these offer tax-free withdrawals, you have to pay taxes on your contributions in the year you make them. So if your goal is to cut your taxes now, stick with a traditional IRA. You can always switch to a Roth IRA for 2022 if that better suits your retirement strategy.