You know that you should be saving for retirement, but that can be easier said than done. However, if you have a workplace retirement account like a 401(k), 403(b), or 457(b), you may not be aware of how much you could save during tax season—and overall—by participating in this account.
Here are some of the basics of a workplace retirement account you should be aware of:
Company match is like free money
Many companies make an additional contribution equal to some or all of the money that employees put into their retirement accounts. That's essentially free money that your company pays you on top of your salary that you can use for retirement. (You may hear it referred to as "the match" or "matching contributions.")
Saving may reduce your current tax bill
Workplace savings plan contributions are typically pre-tax. That means that you reduce your overall taxable income by the amount you contribute and you won't have to pay taxes on that money this year—a double benefit come tax time. Taxes are due when money is withdrawn.
The savings don't stop there—here are just two other lesser-known, but equally compelling, reasons to stash money in your workplace retirement account:
- You may be eligible for the saver's tax credit: Depending on your adjusted gross income and tax filing status, you can claim the credit for 50%, 20%, or 10% of the first $2,000 you contribute during the year to a retirement account. The maximum credit amount is $2,000 ($4,000 if married and filing jointly). A tax credit like this one is even more valuable than a deduction since it reduces the amount of taxes you actually have to pay, rather than the amount of money you owe taxes on. Even better, if you are eligible, you may claim the credit on top of the deduction, for super-charged tax savings. Keep in mind: this particular credit can only be used if you expect to pay taxes this year and is different from the EITC credit described below. Visit the IRS website to learn more.
- It may help you qualify for or increase the earned income tax credit (EITC): The earned income tax credit helps out low- and moderate-income families who work by providing them with a credit at tax time. The amount of the credit depends on a family's income and how many children they have, and it either reduces the amount of taxes owed or becomes a refundable credit. For families who just miss the eligibility cutoff for the EITC, contributing extra money to a 401(k) or 403(b) could potentially reduce your taxable income enough to qualify for the credit.
Let's take a look at the total value of all those benefits in 2018 using a hypothetical example:*
Mike is a married taxpayer filing a joint tax return with his spouse. His gross income is $40,000, his spouse has no earned income, and together they have three children. Mike wants to save money for retirement and decides to contribute $1,000 dollars to his workplace retirement account this year. (Not sure how much you could contribute? Visit the Contribution Calculator.) While that's only about $83 per month, those contributions could be worth more for the year if Mike takes advantage of all the opportunities available through a company-sponsored workplace retirement plan.
- Mike contributes $1,000
- The company matches: $1,000
- The taxes saved on reduced income: $120
- The saver's tax credit: $200
- The increased earned-income tax credit: $211
- Total estimated savings: $2,531
As you can see, the employer matching contributions and associated tax benefit have a positive impact on Mike's savings. His $1,000 yearly contribution leads to $2,531 worth of savings (so Mike has saved approximately 2.5 times more by contributing to his plan).
After looking at how much $83 per month saved this family in both taxes and for retirement this year, it may be hard to find a reason to not participate in your own workplace retirement plan. Next time you consider whether increasing your contributions might be worth it, think of all of the benefits those savings could bring.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917