The importance of saving for retirement cannot be overstated. Taking advantage of tax deferred retirement accounts is one of the best ways to build wealth and ensures your financial security in the future.
The government has instituted maximum contribution levels for these retirement accounts to keep the accounts from being abused by the wealthy as tax havens. The maximum contribution amounts for 401(k) plan accounts and IRAs, the two most popular ways of saving for retirement, are $18,000 and $5,500 respectively. These limits rise to $24,000 and $6,500 if you are over the age of 50.
Roughly 43 percent of IRA holders contributed the maximum possible amount in 2013. The rest are giving up a considerable tax break by failing to max out retirement accounts. Here are some of the benefits you would be missing out on.
Lower Your Current Taxable Income
Contributions to tax deferred retirement accounts like 401(k) plan accounts are deducted from your paycheck on a pre-tax basis. This lowers your taxable income each paycheck and lowers your overall tax bill for the year. You may even qualify for additional tax deductions if your taxable income drops below a particular threshold.
Lower Tax Bills In Retirement
Saving money in a retirement account allows you to put away tax-deferred funds during your prime earning years when you are in a high tax bracket and withdraw it in your retirement years when you are likely to be in a lower tax bracket. Progressive tax rates also ensure that not every dollar will be taxed at the maximum allowable rate for your income. Using this strategy can save you tens of thousands of dollars in taxes over your lifetime.
Account Earnings Are Not Taxed For Decades
Account earnings for the retirement accounts are not subjected to taxes until they are withdrawn from the account. This allows the earnings to grow tax-free for decades and your account balance to grow faster. The power of compounding earnings is how a person that puts away a few thousand dollars a year in their twenties can have retirement accounts worth more than a million dollars when they reach their retirement years.
Increasing The Chances You Won’t Outlive Your Savings
One of the biggest fears for people contemplating retirement is that they will outlive their savings and spend their last years in poverty. If you max out retirement accounts while you are still in your prime earning years, the chances that you will outlive your savings decreases substantially. You may even have money left over to leave to the next generation, increasing their financial stability as well.