Make Tax-Deductible Contributions To Your Retirement Plan
A retirement account can be a useful tax shelter that helps you plan for retirement. An
Individual Retirement Account (IRA) is
better than corporate pension plans, because the money is securely
under your control. Keogh Plans and SEP Plans are usually
better than IRAs for the self-employed, because they allow larger
contributions. An employer-sponsored 401(k) plan is
the best, because it reduces
the taxes that are withheld from your paycheck, and often times companies
will match your contributions to your 401(k) program.
However, you should not contribute to a
retirement plan if you will need the money in the next few years for some good
reason; for example, to buy a house or start a business.
In 2001, the maximum yearly
contribution to retirement IRAs (both traditional
and Roth IRAs) is
$3,000 (more if you're older than 50: see this IRS IRA
article. In a traditional IRA, the money grows tax-deferred until it's
taken out at retirement after age 59.5 (after that,
your withdrawals are taxed.) Annual contributions
are tax-deductible for lower-income people who
aren't covered by an employer's retirement plan.
IRA withdrawals before age 59.5 are subject to a 10% penalty.
There are several exceptions however:
- You can use IRA funds to pay for education expenses.
- You may withdraw up to $10,000 for a first-time home purchase.
- You can withdraw any funds if you're disabled, or you need the money for
substantial medical expenses, or for health insurance while you're unemployed.
You must start withdrawing money from an IRA by age 70.5, or the
IRS will penalize you.
With a Roth IRA, contributions aren't tax-deductible, but you
can withdraw money tax-free after age 59.5. When you die, money from
a Roth IRA will pass to your heirs, free of income tax.
You do have to pay taxes on your income, whichever retirement
account you choose to use. A retirement account will permanently
cut your taxes only if you use it to rearrange your income. You want
to take the tax deduction when you're in the 28% bracket, and get the money
back when you're in a lower tax bracket. Here are some ways you can do
this:
- Take the money out after you retire, when you'll probably be in
a lower tax bracket.
- Deposit money into an IRA for your kids, which they can withdraw at their
lower tax rates.
As a general rule, if you're currently in the 28% tax bracket, you
should deposit money into a traditional IRA to get the tax deduction.
If you're in a lower tax bracket, deposit that money into a Roth IRA.
That's because you'll be taxed now at a low rate, instead of later when you
withdraw the money and have to pay income tax.
You should also investigate a Medical Savings Account
(MSA), an excellent benefit that is
explained in the Business Tax section of this site.
Here's an online tool from Quicken.com to help you check your retirement
plan, and adjust it if it isn't working. It's a bit complex in its
design, so you may have to study it carefully and use the Back
button of your browser a few times.
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Make Tax-Deductible Contributions To Your Retirement Plan 
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Time to complete:
| 15-30 minutes at this 8-step planner |
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Money you'll spend:
| $0 |
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What you'll get:
| A retirement plan. |
Step-by-step instructions:
- Visit Quicken.com's
Retirement Planner (a new window will open).
- If you're not a member of Quicken.com, they'll probably ask you
to register with them.
- Follow the online instructions, which takes you through a lot
of questions to find some good advice to assure a comfortable retirement
for you.
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Further Reading:
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