Ways to Protect Your Retirement Savings from Unnecessary Taxes

Are you looking at retiring in the near future? Even if you still have a way to go before you reach retirement age, retirement planning, and protecting your investments from being over-taxed is a priority, irrespective of your age.

Therefore, the question that begs is, how do you optimize the taxation of your retirement savings?

The concise answer is that you need to consult with a specialist accounting firm, like Philip Stein, who retains experienced, skilled, and qualified accountants to provide accurate and relevant tax advice.

However, before we expand on this statement, let’s first consider a definition of retirement planning as well as a definition of taxes and taxation.

What is retirement planning?

Investopedia.com defines retirement planning as the “process of determining retirement income goals and the actions and decisions necessary to achieve those goals.”

This exercise includes “identifying sources of income, estimating expenses, implementing a savings program, and managing assets and risk.” And finally, it is vital to note that “future cash flows are estimated to determine if the retirement income goal will be achieved.”

In other words, retirement planning is a plan or process that is drafted by a financial expert to help you save a percentage of your monthly salary for the rest of your working life. The amount that is set aside every month depends on your total monthly salary, the optimal amount from a tax point of view, and how long you have to save before retirement. In principle, you should save as much as possible, but as discussed below, the practice is slightly different.

Taxes, taxation, and tax diversification

Now that we have an understanding of what retirement planning is, let’s consider several definitions to do with taxes, taxation, and tax diversification.

Taxes

Once again, Investopedia provides us with the best answer when considering what taxes are.

In essence, taxes are compulsory fees that are levied on individuals and business organizations by a state, federal, or national government. The sole purpose of these taxes is to finance government spending on the necessary activities like paying out social grants and funding government departments that deal with the day to day requirements of ensuring that the country functions smoothly.

Taxation

Taxation is the process of levying the tax by the federal and state governments. Thus, it is reasonable to assume that the definitions of tax and taxation are similar.

Tax diversification

The balance.com notes that tax diversification is a “financial term that refers to the allocation of investment dollars to more than one account type.” It is similar to asset location or the distribution of your investments among different account types to maximize the value through long-term growth.

Ways to leverage the current tax laws to protect your retirement savings from being taxed

It is vital to note that everything discussed in this article is legal. The United States federal and state governments have specific rules and laws around the taxation of retirement savings. This is designed to encourage people to save as much as possible for their retirement.

Therefore, let’s consider some of the more pertinent laws as well as ways to implement them.

Contribute to an IRA

Contributing to an Independent Retirement Account (IRA) will allow you to defer paying taxes on the first $6 000 (USD) deposited in this account. Emily Brandon, in her article titled, “How to Reduce Your Tax Bill by Saving for Retirement,” quotes the following example:

If your monthly wage places you in the 24% tax bracket, and you deposit the full $6 000 into the IRA, you will reduce your federal tax bill by $1 440.

However, it is vital to note that the tax on this money has only been deferred, it is not tax-exempt. It will be taxed when the money is withdrawn from the IRA.

Deposit money in your 401(k) account

A 401(k) account is a retirement savings plan offered by employers to assist employees with saving for their retirement. In general, all monies deposited into a 401(k) remain tax-free until they are withdrawn. Then income tax is payable on the amount withdrawn.

The monies deposited into this account comes directly off your salary before the employer deducts the monthly income tax amount. And, the maximum allowable amounts that individuals can contribute for 2024 are $19 500 for people under 50 years old and $26 000 for people who are 50 years and older. Any amount over these maximum amounts per annum is subject to income tax.

Open a separate IRA for each spouse

A married couple cannot open a joint IRA. However, each member of the marital union can open an individual IRA. This will allow individuals to benefit from double the tax deductions on the maximum tax-deductible amount of $6 000 each. Thus, the couple will save tax on $12 000. This amount increases to $14 000, once both parties are 50 years old and over.