At the end of the year, you probably have a lot of demands on your wallet. You have bills to pay, maybe some holiday gifts yet to buy, and if you are lucky enough to have some cash left over, you may want to treat yourself.
You could buy yourself something nice to enjoy today or you could put the money in a retirement account instead. Here are three reasons the latter might be a smart choice for you.
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1. You could get a tax break today
Contributions to tax-deferred retirement accounts, like traditional IRAs and 401(k)s, reduce your taxable income for the year. This means if you earned $60,000 this year and put $10,000 in a 401(k), you'd only pay taxes on the remaining $50,000 this year. Sometimes, these contributions can even knock you down a tax bracket, resulting in a smaller bill or a larger refund at tax time.
But if you want this tax benefit, you need to steer clear of Roth accounts. These don't offer any tax breaks this year because you get tax-free withdrawals in retirement. But they can still be great places for your retirement savings as long as you recognize that you'll need to pay taxes on all of your contributions this year.
Another thing to be careful of is contribution limits. In 2022, you may only contribute up to $19,500 to a 401(k) or $6,000 to an IRA. Adults 50 and older may contribute up to $26,000 and $7,000, respectively. Contributing more than this will lead to costly penalties.
2. You could qualify for the Savers Tax Credit
The Savers Credit is another way low- and middle-income workers can shave a little off their tax bill while saving for retirement. Unlike the retirement contribution tax deduction discussed above, this is a tax credit. Instead of reducing your taxable income, it reduces your tax bill. If you owe the government $10,000 for 2022 and you qualify for a $2,000 tax credit, you'll now only owe $8,000.
You're eligible for this credit if you meet the following criteria:
- You're 18 or older.
- You're not claimed as a dependent on anyone else's tax return.
- You're not a full-time student.
How much of a credit you get depends on the size of your contribution, your adjusted gross income (AGI), and your tax-filing status. Here's a table showing how much you'll receive:
|
Credit Rate |
Married Filing Jointly |
Head of Household |
Single, Married Filing Separately or Qualifying Widow(er) |
|---|---|---|---|
|
50% of your contribution |
AGI of not more than $41,000 |
AGI of not more than $30,750 |
AGI of not more than $20,500 |
|
20% of your contribution |
$41,001 to $44,000 |
$30,751 to $33,000 |
$20,501 to $22,000 |
|
10% of your contribution |
$44,001 to $68,000 |
$33,001 to $51,000 |
$22,001 to $34,000 |
|
0% of your contribution |
More than $68,000 |
More than $51,000 |
More than $34,000 |
Data source: IRS.
Based on this information, a married couple who earned $40,000 per year and made a $1,000 IRA contribution would see their tax bill reduced by 50% of their contribution -- in this case, $500.
The maximum contribution amount that qualifies for this credit in 2022 is $2,000 for a single adult and $4,000 for a married couple. This yields a maximum credit of $1,000 for single adults and $2,000 for married couples.
3. You're setting yourself up for a more comfortable retirement
The tax breaks discussed above are nice, and they could enable you to buy yourself something even nicer once you get your tax refund. But the real benefit to saving for retirement is the money you'll have in the future. A $1,000 contribution might not seem like it'll go far in retirement, but that could grow to be worth over $10,000 after it's been invested for 30 years with an 8% average annual rate of return. And you could wind up with a lot more if you make bigger contributions.
It's not always easy to lock up your money where you can't easily spend it right now, but it could make a big difference to the quality of your retirement. If you can afford to do so, consider sneaking in one last 2022 retirement contribution before we ring in the new year.
