Yes, contributions to certain retirement accounts, such as a 401(k) or Traditional IRA, can offer tax advantages. Contributions to these accounts are either deducted pretax or reduces your taxable income in the year the contribution is made. Additionally, earnings within these accounts grow tax-deferred until the funds are withdrawn during retirement.
There are various types of retirement accounts, and we will cover them in separate posts in the future.
The 401(k) and IRA are among the most popular retirement plans. Contributions to a 401(k) are made with pre-tax money, meaning that employers deduct these contributions before taxes are withheld from your paycheck and deducted funds are deposited into your 401(k) account. Taxes are then calculated on the remaining gross pay, so you don’t pay taxes on the money you contribute to your 401(k).
An IRA, or Individual Retirement Account, is a personal savings plan that helps you save for retirement while also offering tax benefits. While both 401(k) plans and IRAs are similar in many ways, a 401(k) is typically set up by your employer, whereas an IRA is established by the individual. In a 401(k), your income is reduced by the contributions you make to the plan. In an IRA, the tax benefit comes from deducting your contributions from your gross income. IRA contributions are subtracted from your gross income to calculate taxable income, which provides the tax advantage when filing taxes.
The amount you can contribute to each of these plans is subject to an annual limit, which may change from year to year.