How to Reduce Your Tax Bill by Saving for Retirement

U.S. adults continue to be jittery about their retirement savings. That’s especially the case as the price tag for a secure retirement continues to rise.

According to a recent study by Northwestern Mutual, Americans believe they’ll need $1.46 million to retire comfortably. That figure is 15% higher than in 2023.

One way to reduce those gaps in your savings is to curb your tax burden now and in retirement.

“When saving for retirement, taxes are a huge deal that can really cut into your savings if you’re not careful,” said Andrew Gosselin, a certified public accountant in Princeton, New Jersey, in an email. “With some strategic thinking, however, you can keep more of the money you earned in your own pocket. By planning and being thoughtful about taxes and savings, you protect what’s yours.”

The earlier you begin your campaign to save taxes on your retirement fund, the better. Here’s how to reduce your tax bill with retirement savings:

— Understand the dynamics of taxes and retirement savings.

— Know the best retirement vehicles.

— Know where to invest.

— Match up with your employer.

— Donate with a DAF.

— Don’t go too far with tax strategies.

— Avoid these mistakes.

Understand the Dynamics of Taxes and Retirement Savings

Financial experts say there is a direct relationship between saving taxes and saving for retirement.

“Saving for retirement helps to secure your future and offers tax benefits,” said Rozleen Giwani, a certified public accountant and partner at Grassi Advisors in New York, in an email. “By saving more from your current income, you can reduce your taxable income, thus lowering your tax burden.”

Additionally, starting early allows your savings to benefit from the power of compound earnings growth, amplifying your retirement nest egg over time. “It’s a win-win strategy for financial security and tax efficiency,” Giwani said.

[READ: 10 Steps to Maximize Your IRA]

Know the Best Retirement Vehicles for Lowering Taxes

Choosing the right retirement savings vehicle is crucial for optimizing tax savings and increasing future retirement funds.

“Each option, whether a traditional IRA, Roth IRA or other retirement accounts, comes with tax advantages and considerations,” Giwani noted. “For example, contributions to a traditional IRA can yield immediate tax benefits by reducing taxable income, but withdrawals in retirement are taxed at your ordinary income tax rate.”

Conversely, contributions to a Roth IRA are made with after-tax dollars, but qualified withdrawals in retirement are tax-free. “Understanding the nuances of each option and aligning them with your current financial situation can lead to significant tax savings and a stronger retirement portfolio in the long run,” Giwani said.

For business owners or individuals with self-employment income, there are many other ways to save besides IRA or 401(k) contributions. Here’s a shortlist.

1. SEP IRA. Offering flexibility and higher contribution limits, SEP IRAs allow employers to contribute up to 25% of their self-employed income, up to a maximum of $69,000 for 2024.

2. SIMPLE IRA. Designed for small businesses, SIMPLE IRAs allow both employee and employer contributions. The maximum contribution limit is $16,000 in 2024, plus an additional $3,500 for those aged 50 or older.

3. Keogh plan. While more complex, Keogh plans offer potential retirement savings for individuals with significant self-employment income. Contribution limits are like SEP or defined-contribution plans, allowing for contributions up to $275,000 in 2024.

What to Invest When Using Tax-Advantaged Retirement Plans

Financial advisors agree that the single best investment vehicles for retirement savers are Roth IRAs and 401(k) plans.

“Both are Congress’ greatest gift to taxpayers, allowing young savers to grow their retirement savings and pay no taxes until they retire decades later,” said Peter Tanous, chairman emeritus at Lynx Investment Advisory in the District of Columbia, in an email.

Watch out when choosing investments for those accounts, though. Tanous said most investment advisory predictions are wrong since no one has figured out how to predict the future movement of stocks and funds.

“Consequently, the best course of action for investors is to rely on what has worked over a long period and follow that course,” he said. “The simple fact is that the stock market has been the greatest source of wealth for long-term investors, and we have over 100 years of data to prove it.”

When you start investing in IRAs or 401(k)s, the market doesn’t go straight up, so know that there are sometimes long periods when you earn little or nothing, but there are also no 20-year periods in stock market history where you lose money.

“If you stick with it, you can expect returns of close to 10% a year, and that accumulates over time,” Tanous noted. “With a Roth IRA, you invest after-tax income, but the money grows tax-free, so imagine how it will accumulate over decades.”

Tanous advises putting money away monthly into an index fund such as one that follows the S&P 500.

[READ: Retirement Accounts You Should Consider.]

Match With Your Employer

Another tip for reducing taxes while saving for retirement is to take advantage of any available employer-matching contributions in your workplace retirement plan.

“This essentially gives you free money toward your retirement savings while reducing your taxable income,” said Michael Collins, a certified financial advisor at WinCap Financial in Winchester, Massachusetts, in an email.

Tie Your Donations to Taxes

One vehicle often underutilized is the donor-advised fund, or DAF, where a person can donate cash and appreciated securities and receive a tax deduction. “It’s also a tool to help wealthy individuals remove assets from their estate to stay within the estate exemption limits,” said Stu Sneen, a CFA at TwoTen Planning in Austin, Texas, in an email.

Donating cash to a DAF typically makes you immediately eligible for an income tax deduction worth 60% of your adjusted gross income. If you donate long-term assets like stocks, hedge fund shares or even cryptocurrencies, you earn a tax deduction for the asset’s full market value, up to 30% of adjusted gross income.

The DAF is typical of most complex tax-advantaged strategies, and Sneen recommends getting professional advice before donating.

“Many people probably could do tax management independently, especially if they are claiming the standard deduction,” he said. “However, those who use itemized deductions often have more complicated situations that warrant professional tax services. The U.S. tax code is complex and investors should consider working with a financial planner and/or CPA to help prevent costly mistakes.”

When using a DAF, examine the “bunching strategy” and stack your gift-giving for multiple years in one tax year to reduce your taxable income. “That’s only possible with a donor-advised fund,” said Adam Nash, CEO at Daffy, a charitable giving company based in Los Altos, California, in an email. “Ultrawealthy individuals leverage DAFs to streamline their charitable giving and maximize tax advantages.

[READ: 10 Ways to Reduce Taxes on Your Retirement Savings.]

Don’t Always Prioritize Tax Reductions Over Retirement Savings

Retirement savers may get so absorbed in the process that they prioritize tax reductions over retirement savings when looking to cut tax costs. That’s not a good idea, Sneen said.

“This can lead to a short-term mindset and tactics that could conflict with a long-term savings approach,” he noted. “For example, people in a high tax bracket today may implement strategies to reduce their current income tax. But that may come at the cost of future retirement savings dollars. Additionally, the individual may fail to realize they will likely be in a lower tax bracket once retirement, where those savings dollars will be taxed at a lower rate.”

Avoid These Tax and Retirement Planning Mistakes

Unfortunately, retirement savers — especially those without a professional financial advisor- can make big mistakes when mingling tax reduction efforts with retirement savings. To avoid some of the worst mistakes, follow these guidelines:

Understand tax brackets. Failing to consider your current tax bracket when deciding between Roth and traditional IRA contributions can lead to missed opportunities for tax savings. “It’s essential to choose the right option based on your current and expected future tax situation,” Giwani said.

Track basis in Roth and traditional IRAs. When you start withdrawing funds, tracking your basis in Roth and traditional IRAs is vital for tax purposes. “This ensures you know the tax implications of your withdrawals and can optimize your tax strategy accordingly,” she added.

Take required minimum distributions on time. Missing RMD deadlines can result in significant penalties, so once you reach the required age, staying organized and ensuring timely withdrawals from retirement accounts is essential.

Convert traditional IRA to Roths. Converting a traditional IRA to a Roth IRA can have advantages and disadvantages and weighing them carefully is crucial. “This decision can significantly impact your tax liability and retirement savings, so understanding the pros and cons and consulting with financial professionals is essential before making a move,” Giwani said. “Additionally, it’s typically irreversible once converted, so careful consideration is necessary.”

Avoiding these mistakes requires careful planning and ongoing monitoring of your financial situation. “That means consulting with tax and financial advisors to ensure that your retirement savings and tax reduction strategies align with your goals and circumstances,” Giwani noted.

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How to Reduce Your Tax Bill by Saving for Retirement originally appeared on

Update 06/10/24: This story was previously published at an earlier date and has been updated with new information.

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