The April 15 tax deadline is upon us, and taxes are the foremost personal finance subject we tend to think about this time of year. However, there are bigger picture financial topics that taxes can make us aware of, such as retirement. Here's a look at taxes in conjunction with retirement issues.
Retirement is one of the most common financial planning topics, and it's never too early to start preparing for a secure retirement. There are various types of retirement accounts that have tax advantages that can help retirement funds grow over time. I'll cover a few of the most common types as they apply to taxes now and in the future.
What retirement plans can you still contribute to for your 2012 tax return?
Up until April 15, 2013 you can still contribute to a regular IRA (individual retirement account) or Roth IRA. According to the IRS the maximum contribution for 2012 is $5,000 annually to your IRAs ($6,000 if you are 50 or older by the end of the year), assuming you have at least $5,000 ($6,000) in earned income for the year. There are a variety of other retirement accounts so be sure to check on the timing of their contribution requirements.
How do retirement plan contributions help your taxes now?
If you contribute to an IRA or 401(k) (these are two of the most common types, but this also applies to 457 plans, 403(b) plans, SEP IRAs and SIMPLE IRAs as well), you will receive a tax advantage now. Earnings contributed to the account will lower your taxable income in the tax year contributions are made.
Which accounts don't help my current tax burden? Why might I contribute to them anyway?
Some accounts (like a Roth IRA) do not allow you to deduct your contributions for your current taxes. In other words, you pay tax on that money up front. However, that doesn't mean you shouldn't contribute. Roth IRAs have a number of advantages and are generally appropriate for workers who believe their income (and therefore their taxes will increase in the future). Or if you have a lot of funds built up in traditional retirement vehicles a Roth can give you more tax planning options when it comes time to pull money out of accounts for retirement.
How can you plan ahead for next year?
Make retirement a priority in some capacity. Even small amounts ($50 per month) contributed consistently can add up over time. One common mantra of financial planners is to "contribute early and often" to retirement plans. If possible, make automatic contributions from your paycheck directly into your retirement account. Try to put 10 to 20 percent of your paycheck toward retirement. Be aware of the contribution and salary limits for various types of accounts. If you've maxed out your retirement accounts (congratulations!) you can still put money in a brokerage account to continue to save (and invest) for retirement and your other goals.
The establishment of emergency savings is an important part of your overall plan and preserving your retirement savings. That way if something bad and unexpected happens, you're not dipping into retirement savings (and likely paying a steep penalty) in order to get through financial hardship. Even if you don't have to pay a penalty (like when taking principle out of a Roth account under certain conditions) you still want to avoid early withdrawals. It is very difficult to make up contributions to the account, so you will have fewer resources to grow over time.
Please remember that everyone's tax situation is a little different. If you think some of the ideas in this post apply to you, be sure to reach out to a qualified tax professional. Consider how to maximize your tax savings in conjunction with your retirement savings and coordinate the two to SaveUp!
This post was written by SaveUp's personal finance contributing writer, Catherine Hawley, CFP®.