We are all guilty of putting something off until tomorrow that can be done today. Even though the April 15 deadline for filing federal individual income tax returns is ingrained in our memory, many people still wait until the last minute to take action.
While the deadline is growing close, there's no need to panic. For most taxpayers, saving for retirement is one the most efficient ways to lower your taxes while simultaneously building a nest egg. Following the last minute tips below can help you not only boost your tax refund but also kick start your retirement savings.
Tip #1: Contribute to an Individual Retirement Account (IRA)
One recommended way to reduce your tax bill is to open an individual retirement account or increase your contributions to an existing account. Contributing to an IRA not only helps raise your level of retirement readiness, but placing money into the account can also lower your total taxable income. The more you contribute to the IRA, the less of your income is subject to taxes, for those that qualify. While anyone can contribute to an IRA and enjoy tax-deferred growth, not everyone can deduct contributions. Eligibility depends on your marital status and whether you or your spouse has a retirement plan available at work. If you're single and don't have a retirement plan at work, your IRA contribution is entirely deductible. Similarly, married couples where neither spouse has access to a retirement plan get full deductions as well. The idea here is that if your IRA is your only retirement plan, the government wants to encourage you to use it fully.
IRA contributions, which are tax deductible up to $5,500 ($6,500 if you're over 50), can be made until April 15 and often result in tax savings. Every dollar you contribute to a traditional IRA reduces your taxable income for that year.
If you do qualify for the deduction, remember to specify that the contribution is for the 2013 tax year. If you don't specify the year, you could end up contributing towards your 2014 IRA, which will decrease your tax bill a year from now but won't do anything for your current tax bill.
Tip #2: Claim a Saver's Tax Credit
This credit is often overlooked and seldom talked about. If you have an income up to $29,500 ($59,000 for married filing jointly), you can save for retirement and get a tax credit worth up to $1,000 for individuals and $2,000 for couples if you contributed to a qualifying retirement plan such as an IRA or 401(k).
Tip #3: Fund a Health Savings Account (HSA)
As healthcare costs continue to spiral, funding a health savings account can be another way to lower your tax liability while saving for unexpected healthcare costs in retirement.
HSAs are tax-deductible savings plans that allow a taxpayer to save pre-tax dollars for future healthcare expenses. HSAs are paired with a high-deductible health plan and are one of the most tax-advantaged vehicles because contributions are tax-deductible and qualified distributions are tax-free. It is one of the few savings options that is completely tax-free.
The annual contribution limit for 2013 is $3,250 ($4,250 if you're over 55) for self-only coverage and $6,450 for those with family coverage and can be made until April 15.
Save on Taxes and Grow your Savings All Year Around
The biggest mistake made by taxpayers year in and year out is procrastination. Following the above tips will provide you with an immediate tax break to file your 2013 return, but it's also important to make sure you implement an effective tax strategy for the long-term. Consider the following tips to get a head start on lowering your 2014 tax bill.
Tip #1: Enroll in your Workplace Retirement Plan
For many taxpayers, contributing to a tax-advantaged savings account provides the greatest opportunity for tax savings. Contributing money to a workplace retirement plan, such as a 401(k), provides you with an immediate tax deduction and tax-deferred growth on savings. The money you contribute is tax-deferred from both federal and state income taxes, which means you don't pay taxes on the contributions until you withdraw the funds, typically at retirement age. For example, if you are in the 28 percent tax bracket and you invest $5,000 a year, that's $5,000 of your salary on which you are not paying taxes. This reduces your annual tax bill on that $5,000 by nearly one-third -- $1,400 ($5,000 x .28). Furthermore, contributions to the plan are deducted automatically from your paycheck, making the process seamless for you. By contributing even a small amount on a regular basis, you can works towards building retirement savings over the long-term and pay yourself instead of Uncle Sam.
Tip #2: Increase Retirement Plan Contributions
Another way to lower your tax bill is to reduce your taxable income. If you're already enrolled in your retirement plan at work, consider increasing your contributions. Money contributed to the plan is not included in your taxable income. You can contribute up to $17,500 to your 401(k) or similar retirement savings plan in 2014. If you aren't going to reach that limit and can afford to, additional contributions will save you at tax time. If you are age 50 or older (or will be by the end of the calendar year) and your plan allows, take advantage of the "catch-up" provision. In addition to the $17,500 general deferral limit, you can contribute an additional $5,500 for a total of $23,000. This means if you are 50 years old this year and haven't started saving for retirement, you can contribute as much as $225,000 over the next ten years -- tax-deferred -- to your 401(k) plan. Investing in your retirement plan now allows you the potential to grow your retirement nest egg tax-free for tomorrow and get tax savings today.
Tip #3: Leverage Both Pre-tax and Post-tax Contributions
If your plan allows for both traditional pre-tax and after-tax (Roth) contributions, evaluate which is a better option with your individual situation. You also have the option to split the deferral types. While pre-tax contributions allow you to contribute to the plan on a pre-tax basis, Roth contributions allow you the opportunity to grow these contributions tax-free. This is a valuable feature if you believe your taxes will be higher when you retire, since you will pay taxes on the contributions now based on a lower tax bracket and pay no taxes on the earning when you retire.
Abraham Lincoln once said, "You cannot escape the responsibility of tomorrow by evading it today." Following these tips can help you conquer the panic today of tomorrow's tax-filing responsibility while simultaneously building your nest egg and driving increased retirement readiness.
About the author:
James Nichols is head of Retirement Income and Advice Strategy for the Retirement Solutions business at Voya Financial, which is rebranding this year from ING U.S. This strategic business segment is focused on guiding Americans on their journey to greater retirement readiness through employer-sponsored, tax-deferred savings plans, as well as through holistic financial planning and advice for customers nearing or in their retirement.
Neither Voya Financial nor its representatives offer legal or tax advice. Consult with your tax and legal advisors regarding your individual situation.
James Nichols is a registered representative of ING Financial Partners and ING Investment Advisors, LLC (members SIPC).