Tax Breaks & Retirement Savings

by Michael Dreiser, studioD

The Internal Revenue Code offers individual income tax payers a wide array of tax advantaged retirement plans. These plans typically allow taxpayers the benefit of either tax-free contributions, or distributions in addition to a tax deferral for all investment earnings in established retirement accounts.

Traditional IRAs

A traditional individual retirement account (IRA) allows taxpayers to reduce adjusted gross income for federal individual income tax purposes by the amount of contributions to the IRA account. Contributions for any taxable year may be made until April 15 of the subsequent tax year. Maximum contribution limits to traditional IRAs are much lower than to many other tax advantaged retirement plans. Currently, taxpayers can deduct up to $5,000 in contributions in any given tax year (the limit is increased to $6,000 for taxpayers age 50 and older). Upper income taxpayers covered by an employer-sponsored IRA are not eligible to contribute to an IRA.

Employer Sponsered IRAs

The primary employer sponsored IRA plans are 401(k) accounts, which are sponsored by private employers. A 403(b) plan is similar, but is sponsored by public educational institutes and non-profit organizations. Both plans, like traditional IRAs, allow taxpayers to contribute amounts on a pretax basis to their retirement accounts. Amounts contributed to these employer sponsored IRAs are not considered part of federal adjusted gross income. Contribution limits are generally much greater than those with traditional IRAs, currently $16,500 per year, with an increased limit to $21,500 for taxpayers age 50 and older.

Income Deferral

The traditional IRA and employer sponsored IRA accounts allow a significant tax benefit through the deferral of investment income. Amounts contributed and all investment earnings are not taxable until distributed. Upon distribution, all amounts distributed are taxed at ordinary income tax rates. Account holders can't take distributions prior to age 59 1/2f without incurring a 10 percent penalty on distributions. Annual distributions become mandatory at age 70 1/2.

Roth IRA

Another popular tax advantaged retirement plan is a Roth IRA. A Roth IRA provides no tax benefit at the time funds are contributed to retirement accounts. Instead, all amounts contributed grow tax deferred and are not taxed at the time of distribution. Contributions limits to a Roth IRA are equivalent to those of a traditional IRA, although a hybrid employee sponsored Roth 401(k) plan combines the tax benefits of a Roth IRA with the contribution limits of 401(k) plans. In addition, unlike with traditional IRA plans and employer sponsored 401(k) and 401(b) plans, there is never a penalty for distributions up to the amount contributed to the plan.

About the Author

Michael Dreiser started writing professionally in 2010. He is a certified public accountant with experience working for a large New York City accountancy and expertise in areas ranging from private equity taxation to investment management. He holds a Master of Business Administration in international finance from l’École Nationale des Ponts et Chaussées in Paris.

Photo Credits

  • George Marks/Retrofile/Getty Images