Five reasons to take advantage of tax-deferred retirement savings plans
Let your savings reach their full potential with tax-deferred accounts
Deferring your tax liability until retirement can be a smart way to minimize taxes and maximize the growth of your retirement savings. But there are annual limits on how much you can contribute to tax-deferred retirement accounts, such as traditional IRAs and employer-sponsored plans like 401(k)s. With these accounts, your contributions are typically deductible now, and you’ll only pay taxes on the funds you withdraw in retirement.
Here are five compelling reasons to maximize your contributions to tax-deferred retirement savings plans:
1. Lower your tax bill right now
Tax deductions are powerful financial tools. Making the maximum contributions to your tax-deferred accounts effectively takes a chunk of money you would have paid to the government and lets you keep it now and pay it later instead. The higher your tax bracket, the more you will save. Even if your income is lower, you may still be able to realize a significant tax benefit by qualifying for the saver’s tax credit.
2. Raise the potential for compounding
Compounding is a basic principle of investing. Say you invest money in an account that produces earnings. The earnings you receive start producing earnings of their own, and the cycle continues over time. Because tax-deferred accounts allow you to invest funds before you pay taxes on them, you give more of your current funds an opportunity to take advantage of this “magical” mechanism.
3. Save on taxes over the long term
Many people expect to earn less in retirement than they did in their working years as they downsize and shift to relying on pensions, Social Security and retirement accounts for income. As your income drops, your tax bracket may drop, too. In that case, you could wind up paying less in taxes over time, since your withdrawals in retirement would be taxed at a lower rate than those funds would have been when you were working.
4. Eliminate taxes on investment gains
Usually, when you sell stocks or other assets that have grown in value since you bought them, you realize a capital gain, which triggers a related tax. But within a tax-deferred account, you can buy and sell assets without triggering any tax at all. You can feel free to make investment moves without worrying about the effect of a sale on your current tax situation ― as long as that money stays in your tax-deferred account.
5. Support your savings discipline
Except in special cases, withdrawing money from a traditional IRA or employer-sponsored plan before the age of 59½ will come with a sizable penalty. Why is that a good thing? Because one of the biggest impediments to building your retirement savings is the temptation to tap into it early to cover your current expenses. Keeping the money in your tax-deferred account can be a powerful incentive for avoiding early withdrawals.
Supplement your tax-deferred savings plans with an Empower Investment Account
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