One of the easiest ways to reduce your income tax each year is to contribute a portion of your income to a 401(k) or traditional Individual Retirement Arrangement (IRA). For example, if you earned $70,000 in a year and contributed $5,000 to your IRA, your taxable income would drop to $65,000 for that year.
You can also invest that money in a Roth IRAs. Roth IRAs only take post-tax dollars, but the money can be withdrawn tax-free once you’re retired. Most employees in the United States have an option to contribute to one of these types of plans, and their contributions may be supplemented or matched by their employers depending on the details of the plan.
When it comes to the maximum amount you’re allowed to contribute to your IRA and 401(k) accounts, Congress limits this amount to prevent fraud. Traditionally, Congress has adjusted this contribution limit to keep pace with inflation. Recently the Internal Revenue Service (IRS) released its pension plan changes for the upcoming year, and the results have raised both questions and concerns.
For small business owners and the self-employed, the new 2014 rules offer a little more room for savings; small businesses can save up to $52,000 in a solo 401(k), up by $1,000 from the 2013 maximum. The new compensation limit used in calculating contributions goes up to $260,000, from the $255,000 maximum. High-earning self-employed workers are also seeing a boost in how much they can save.
For wage and salary workers, the new rules don’t offer any changes. The contribution limits for both types of accounts—IRAs and 401(k)s will remain at the same levels for 2014 as they were for this year. Analysts say that this is a rare and frustrating move from the IRS, as they have increased the contribution limits for the past two years to keep up with inflation; however, the Consumer Price Index rose only 1.2 percent this year, which couldn’t justify a change. This means that taxpayers may contribute up to $17,500 to their 401(k) in 2014, and up to $5,500 to an IRA.
Employees age 50 or older can make an additional $5,500 catch-up contribution to their 401(k)s, and $1,000 to IRAs, the same as the 2013 tax year. The maximum amount that can be deposited to a defined contribution plan account has risen to $52,000 — this is up from $51,000 in 2013. This number includes all contributions made by both employer and employee over the calendar year. Additionally, certain deduction qualifications have been modified depending on the status of your household and the amount of taxable income you’ll make next year.
What does this all mean? People who were seeking to max out their contributions for 2014 won’t be able to grow their nest egg by more than they were able to this year. They also won’t be able to deduct any more than the limit amount from their taxes to be written off as retirement contributions.
Research indicates that a very small number of Americans — between five and 11 percent — do not max out their contribution limits to their retirement accounts; experts recommend doing so whenever possible, because the more money you can deposit in your retirement account now, the more you’ll end up with when you need it.
The other good news is that the forecast for 2015 looks much more favorable. The regular contribution limits and the catch-up limits are due to rise, and all that needs to happen is for inflation to increase by just one percent.
The overall lesson is to do your research in 2014 to max out your retirement savings and create the smartest tax plan possible. It’s easy to make a resolution to be smarter with your cash in the new year. Getting educated about your retirement savings is a great way to stick to that promise.