You may already know that 401K programs are an efficient way to save for retirement. But did you know that they’re one of the easiest ways to pay less in taxes this year? The money you contribute to your 401K doesn’t get included in this year’s taxes. Instead, it goes directly into investments. Let’s take a closer look at how maxing out your 401K can be a tax-reducing machine.
You Pay Less, You Make More
401K programs allow you to defer paying income tax until you withdraw the money during retirement. So long as you wait until after you’re 55, you won’t have to pay additional penalties for withdrawing your funds.
By the time you retire, your tax rates will likely plummet. The taxes you pay upon withdrawal are based on your salary at the time of withdrawal. By the time most people retire, they’re making significantly less than they were at the peak of their professional career. To even further reduce the amount tax you pay, consider moving to a state with a low-income tax rate when you retire.
Getting The Most Out Of Your 401K
Many employers offer matching 401K programs. If you can afford to, you should contribute the maximum amount that your employer is willing to match. Not only will this money be tax-deferred, but half of it will be money to didn’t even earn. It’s free money! Employers typically match up to 3 percent of your income.
If you make $75,000 a year, 3 percent equates to $2,250. Your employer would match that, earning you an additional $2,250 each year. All that money, a total of $5,000, would go directly into your retirement portfolio. A 401K is composed of stocks and bonds. It grows over time and continues to make you even more money.
Why pay taxes on your money now? By maxing out your 401K, you can defer a significant portion of your income tax until you retire. When you retire, you’ll likely be in a lower tax bracket. You make more in the long run and pay less in taxes!