The Perks of Investing in a Retirement Account

By Eric Tyson

Where possible, try to save and invest in accounts that offer you a tax advantage, which is precisely what retirement accounts offer you. These accounts — known by such enlightening acronyms and names as 401(k), 403(b), SEP-IRA, and so on — offer tax breaks to people of all economic means. Consider the following advantages to investing in retirement accounts:

  • Contributions often provide up-front tax breaks. By investing through a retirement account, you not only plan wisely for your future, but you also get an immediate financial reward: lower taxes, which means more money available for saving and investing.

Retirement account contributions generally aren’t taxed at either the federal or state income tax level until withdrawal (but they’re still subject to Social Security and Medicare taxes when earned). If you’re paying, say, 30 percent between federal and state taxes, a $4,000 contribution to a retirement account lowers your taxes by $1,200.

Modest income earners also may get an additional government tax credit known as the Retirement Savings Contributions Credit. A maximum credit of 50 percent applies to the first $2,000 contributed for single taxpayers with an adjusted gross income (AGI) of no more than $18,500 and married couples filing jointly with an AGI of $37,000 or less.

Singles with an AGI of between $18,500 and $20,000 and married couples with an AGI between $37,000 and $40,000 are eligible for a 20 percent tax credit. Single taxpayers with an AGI of more than $20,000 but no more than $31,000, as well as married couples with an AGI between $40,000 and $62,000, can get a 10 percent tax credit.

  • Your employer may match some of your contributions. This money is free money from your employer, and it’s use it or lose it, so don’t miss out!
  • Investment returns compound tax-free. After you put money into a retirement account, you get to defer taxes on all the accumulating gains and profits (including interest and dividends) until you withdraw the money down the road. Thus, more money is working for you over a longer period of time. (One exception: Roth IRAs offer no up-front tax breaks but permit tax-free withdrawal of investment earnings in retirement.)