Whether you are contributing to your 401(k) or are considering it, here are 8 strategies to reduce the taxes you pay on your retirement savings.
1. Be sure that 100 percent of your 401(k) contributions come from income that is already taxed at the federal and state level. Employer contributions seem like "free money" to some employees, and they too often come from taxable income, which creates an unnecessary additional tax.
2. Be sure you understand your employer's vesting schedule (how long you must work for the company before becoming 100 percent vested in your account). Vesting schedules can last as short as one year or as long as six years, depending on your employer. The longer the vesting schedule, the longer you will have to work for your company before becoming totally vested in any employer match contributions.
3. If you change jobs during a particular year and roll over your 401(k), consolidate it with your current job's plan if possible. Transferring multiple plans can create additional fees and lead to lost investment gains.
4. Look into your employer's plan to see if it offers Direct Deposit for your 401(k) contributions. Having your contributions directly deposited into your account will help you track them more easily (and accurately).
5. If you do not save at least enough in tax-deferred accounts to claim the full deduction, consider contributing to a Roth account. While your contributions won't be deductible, you will not have to pay taxes on the withdrawals in retirement.
6. If you are age 50 or older by year-end this year, consider making additional catch-up contributions of up to $5,500 ($2,500 if you are still working for your employer). If your company limits matching contributions to 100 percent of your salary, consider contributing the maximum in order to get the full free money from your employer.
7. Watch out for 401(k) fees. Expensive fees can easily eat away at returns over time so minimize them by "do it yourself" investing in mutual funds with low fees, staying in your plan's lower-cost stock and bond options, minimizing the number of fund choices offered by your employer or seeking out plans with fewer investment choices.
8. If you are thinking about retiring soon, consider starting to take income from your 401(k) this year to help reduce last year's taxable income. You will likely be in a lower tax bracket this year and may have less money to take as a distribution next year when you retire, so there is no downside to taking your distributions this year if you need the cash flow.
(Please note that this information is general in nature and should not be construed as personal advice.)
