Some tax perks for retirement savers are phased out for people who earn above a certain amount, including the ability to claim the saver’s credit or contribute to a Roth IRA. But there are plenty of other tax benefits that people with relatively high incomes enjoy. Here’s a look at some of the retirement savings tax incentives available to people with six-figure incomes.
[See: 10 Tax Breaks for Retirement Savers.]
A bigger 401(k) tax deduction. Workers with high incomes have the most to gain by contributing to a traditional 401(k) plan. “Make sure you are taking advantage of all of the tax-deferred vehicles available to you,” says Helen Berenyi, a certified financial planner and president of the wealth management firm Red Triangle in Charleston, South Carolina. “Any type of tax-differed growth you can get is worth doing.” You can defer paying income tax on the amount you contribute to a 401(k) plan, and the higher your tax rate the more money you save by delaying the tax. For example, an employee in the 35 percent tax bracket who completely maxes out her 401(k) by contributing $18,000 will reduce her tax bill by $6,300. A worker in the 25 percent tax bracket who saves the same amount in a 401(k) would reduce his tax bill by $4,500. Income tax won’t be due on these contributions until the money is withdrawn from the account. Only 12 percent of participants maxed out their 401(k) plan in 2015, and most of the people who did earned $100,000 or more, according to 2015 Vanguard 401(k) plan data.
Catch-up contributions. People who are age 50 or older are eligible to contribute an additional $6,000 to a 401(k) plan, or $24,000 in total. However, only about 16 percent of 401(k) participants take advantage of catch-up contributions, and most of the people who do earn at least $100,000 annually, Vanguard found. An older worker who maxes out his 401(k) plan would reduce his tax bill by $8,400 if he is in the 35 percent tax bracket, but the dollar value of the tax deduction declines to $6,000 for a worker paying a 25 percent tax rate. “You can get a tax deduction on the 401(k) contribution, and all of that compounded interest grows tax-deferred,” says Steve Taylor, a certified financial planner and president of Colt Financial in Franklin, Massachusetts. When the money is withdrawn from the account, income tax is paid at your current tax rate. If you drop into a lower tax bracket in retirement, you will pay less tax on that money than you would have if it were taxed in the year you earned it.
[Read: How Your 401(k) Balance Stacks Up.]
IRA charitable contributions. Withdrawals from traditional IRAs are required after age 70 1/2, and most people need to pay income tax on each distribution. However, if you are in the fortunate position of not needing the money stashed away in your IRA, you might be able to avoid income tax if you donate a distribution directly to charity. “Older retirees who don’t necessarily need the income coming from the required minimum distribution can decide to make a donation,” says Timothy Baker, a certified financial planner and CEO of WealthShape in Manchester, Connecticut. “It’s always best that it be made payable directly to the charity.” Retirees who are 70 1/2 or older can directly transfer any amount up to $100,000 to a qualified charity without having to pay income tax on the distribution. This charitable contribution will also satisfy your IRA minimum distribution requirement.
No more Social Security tax. Most workers pay a portion of every dollar they earn into the Social Security system. However, high earners pay Social Security tax on only part of their salary. Employees pay 6.2 percent of their earnings into Social Security on up to $118,500 in 2016. Earnings above this amount are not subject to Social Security tax or factored into retirement payouts. “You are still going to continue to pay Medicare taxes, but that tax associated with Social Security does go away,” Baker says. “You find a lot of people excited about that when they get their paychecks and it’s a little bit higher than it was previously.” The Social Security taxable maximum is automatically adjusted each year to keep pace with inflation.
[Read: How to Pay Less Taxes on Retirement Account Withdrawals.]
What well-paid savers miss out on. There are also a few retirement savings tax perks that aren’t available to high earners. For example, Roth IRA eligibility phases out for workers whose adjusted gross income is between $117,000 and $132,000 ($184,000 and $194,000 for married couples). And you can’t claim a tax deduction on contributions to both a 401(k) and an IRA if your modified adjusted gross income is more than $71,000 ($118,000 if both spouses have access to workplace retirement plans). Higher earners also pay an additional Medicare tax of 0.9 percent on earnings above $200,000 for individuals and $250,000 for couples.
Emily Brandon is the author of “Pensionless: The 10-Step Solution for a Stress-Free Retirement.”
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Retirement Savings Tax Breaks for High Earners originally appeared on usnews.com
