How to Save for Retirement and Reduce Your Taxes

So you finally have extra cash or you have rearranged your priorities and you are ready to invest for retirement (a goal we all have in common). What next?

You want to set it aside and invest it. Invest it to maximize its long-term investment growth and at the same time invest it in a way to minimize the tax bite. Here is the quick and dirty from a tax savings perspective:

Employer-Sponsored Retirement Plans

If your employer offers a tax-qualified plan, participate in the plan to the best of your ability and at the very least contribute enough to get the full employer match. The employer match is free money. Take it! (For related reading, see: If Your Company Is Matching 401(k)s, Max It Out!)

No Employer Retirement Plan?

If your employer does not offer a plan or if you are self-employed and do not have a tax-qualified plan, open a traditional IRA. You can go to Vanguard.com and open it online. As long as you have earned income you can open an IRA. The IRA contribution limit (that is the maximum tax deduction) for 2017 is $5,500, or $6,500 if you are over age 50. Your spouse may also be eligible to contribute to a spousal IRA. Unfortunately, if you earn too much or if either you or your spouse participate in another employer-sponsored plan, you may be limited in the tax deduction, but you can still invest. (For related reading, see: How IRA Contributions Affect Your Taxes.)

Retirement Options for Business Owners

If you are a small business (or S Corporation) owner, you have other options. You can still do an IRA, however, you may also consider a SEP IRA, SIMPLE IRA or a solo 401(k), all of which have their own pluses and minuses:

  • SEP IRA: Under a SEP plan, contributions are made by the business—not the individual—and it can contribute up to 20% of its income for the sole proprietor or partner and up to 25% of the employee's (such as an S corporation) salary (up to $52,000). SEPs are relatively inexpensive to set up, but all eligible employees need to receive the same percentage, which can be zero if cash flow is tight in some years. Contributions are also pre-FICA.
  • SIMPLE IRA: With a SIMPLE IRA, each employee decides to make a pretax contribution up to $12,500 to an IRA from their wages. The employer then matches up to 3% of the employee's wages. SIMPLEs are relatively easy to establish and inexpensive both in terms of administrative costs and funding (employer only pays the 3% match). The employee contributions are subject to FICA, but the employer's 3% is not.
  • Solo 401(k): A solo 401(k) works well for a one-person or married couple S corporation. The employee (or S corporation owner) can contribute up to $18,000 out of their wages. The corporation can then match some portion of that contribution or up to the lower of 25% of your salary or $52,000. Employer contributions are discretionary and can be eliminated when cash flow is thin. The employee contribution is subject to FICA but the corporate match is not. Solo 401(k)s are relatively easy to establish and have low administrative costs. (For related reading, see: How a Solo 401(k) Can Increase Retirement Savings.)

Alternatively, you may also consider a Roth IRA, which is made up of after-tax funds. Or you can maximize contributions to your HSA account if you have one. Since HSA contributions are tax-deductible, funds can be accumulated and it will act more like an IRA after you turn 65.

In any event, get started. Save early, save often and do so in a way that minimize both taxes and expenses.