The Fastest Way to (Legally) Reduce Your Tax Bill

There are plenty of deductions and tax credits available in the United States tax code that can help you save hundreds or thousands of dollars each year. But perhaps the fastest way to save money on your taxes is to simply pay a visit to your payroll department and tell them you'd like to increase your retirement contributions.

How much can you set aside for retirement?

The amount you can set aside for retirement depends on the type of retirement plan you have at work, your income, and a few other factors. Let's start with the common workplace retirement plans.

401(k)s and more

401(k), 403(b), 457, and Thrift Savings plans all have a $23,000 limit on elective deferrals (money you choose to contribute through payroll deductions) for 2024. In most cases, there's also a $7,500 catch-up contribution allowed for participants aged 50 and older. For example, if you're 52 this year, you can choose to have your employer take up to $30,500 of your pay and put it into your 401(k).

It's also worth noting that these limits don't include any matching contributions your employer makes on your behalf. Let's say that you have a salary of $100,000 and your employer will match your contributions up to 6% of your salary -- this means they are willing to put in as much as $6,000, and this does not count toward your elective deferral limit.

IRA limits

The individual retirement account (IRA) contribution limit for 2024 is $7,000, with a $1,000 catch-up contribution allowed for account owners 50 and older.

While IRAs are primarily designed for people who don't have retirement plans through employers, it's important to realize that you can have an IRA and a 401(k) or similar plan at the same time. Depending on your income, you might even be able to take a full tax deduction for traditional IRA contributions and participate in your employer's plan.

Self-employed retirement accounts

If you're self-employed, the retirement savings contribution limits can be even higher, since you are considered both the employee and the employer. The three most common account types used by self-employed individuals to save for retirement and their limits are:

1. Solo 401(k): You can open a one-participant 401(k) plan if you're self-employed. The total solo 401(k) limit is $69,000 for 2024, plus the $7,500 catch-up allowance for those aged 50 or older. With Solo 401(k) accounts, you can contribute as much as $23,000 as the employee as well as up to 25% of your net self-employment income as the employer's contribution.
2. SEP-IRA: The SEP-IRA contribution limit is also $69,000 for 2024. However, since all SEP-IRA contributions are technically from the employer, this is capped at 25% of your compensation. There are no catch-up contributions (these apply to employee contributions only).
3. SIMPLE IRA: For 2024, employee contributions to a SIMPLE IRA are capped at $16,000 ($19,500 if 50 or older). You can also contribute 3% of your compensation as an employer contribution, considering a maximum of $345,000 in compensation in the calculation.

How much could you save on your taxes?

Of course, your potential tax savings have several different contributing factors. It depends on the type of retirement account you're using, your income, your other tax deductions, and more. But let's look at an example.

Let's say you're 40 years old, single, and have a 401(k) at work. We'll say that (aside from the effects of retirement contributions) you have a taxable income of $100,000, which puts you in the 22% marginal tax bracket. If you contribute $7,000 of your salary to your 401(k) plan today, you'd save $1,540 on your taxes as opposed to if you hadn't contributed at all.

However, let's say that you decide to take full advantage and contribute the 2024 maximum of $23,000. This would translate to an additional $3,520 in tax savings based on your 22% marginal tax rate (and that's not to mention the massive addition to your retirement nest egg).

Should you take advantage?

To be perfectly clear, I completely understand that it might not be practical (or even necessary) to put as much money into your retirement accounts as is legally allowed. In other words, not everyone who participates in a 401(k) could reasonably put $23,000 into their account in 2024 without incurring excessive financial strain.

However, the point is that there may be more room to increase your retirement contributions than you might think. Not only could increasing your retirement contributions save you a ton of money on your taxes, but you'll also be setting yourself up for a more secure retirement down the road.