Don't Mess With Taxes

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Millions of people whose student loan debt will be wiped out now face another financial question. What to do with a bit more disposable income.

Financial advisers suggest they pay off other debt, such as high-interest credit card balances. That's a smart move. So is the recommendation that folks put their newly available former debt payments into an emergency fund.

I'd like to also toss out there the option of saving for retirement. As an added bonus, most retirement account options offer some sort of tax benefit.

Here are some tax-favored retirement-saving possibilities that would be great places to put that former student loan payment.

1. Roth IRA: Young workers should open a Roth IRA. While you don't get an immediate tax break, when you do retire many years down the road, you can take out the Roth funds, both your contributions and earnings, tax-free. And you can do so whenever you, not Uncle Sam, wants. There's no required minimum distribution (RMD) for Roth IRAs. And since the money you put into the account was already taxed, you can take those funds out any time without penalty.

2. Traditional IRA: Some individuals like this grandfather of individual retirement arrangements because it offers an immediate tax break. It's an above-the-line write-off on Form 1040 Schedule 1 that reduces your adjusted gross income. It's a relatively easy income adjustment if you (or you spouse) don't have a retirement account at work. A bit more calculation is required if you (or your spouse) do have a saving plan at work. Still, many find the tax filing work worth it for the tax savings at filing time.

With either a traditional or Roth IRA, you must have earned income to contribute. The amounts you can put into them is adjusted annually for inflation. For 2022, that's $6,000. If you're age 50 or older, you can add an additional $1,000 to your IRA, Roth or traditional.

3. 401(k) plan: Speaking of workplace retirement savings, the most popular version is the 401(k). If you work for a nonprofit, these accounts are known as 403(b) plans. They are 457(b) accounts for state and local government workers. And yes, you guessed correctly; the names come from the Internal Revenue Code provisions that created the various defined contribution retirement plans. For simplicity's sake, I'm just going to use 401(k) for future references in his post.

You put money into your 401(k) via payroll deductions. Most companies match at least a portion of your contributions. Since your 401(k) contribution amounts are made before taxes are figured, you could see a bit more in your paychecks after you enroll in your employer's plan. Some companies also offer Roth versions, which like the similarly named IRA, are added to with already taxed dollars. Also, as with Roth IRAs, Roth 401(k) distributions ultimately are tax free.

4. Self-employed retirement plans: If you are your own boss, you have a variety of retirement plans from which to choose. These most popular are SEP IRA, SIMPLE IRA, and solo 401(k). You can read more about these in my earlier post 3 popular retirement plans for the self-employed. Also check out IRS Publication 560, Retirement Plans for Small Business.

Another benefit of saving for retirement when you're self-employed is that your contribution also provides you an immediate tax deduction. On that same Form 1040 Schedule 1 mentioned earlier in connection with the above-the-line traditional IRA deduction, you also can claim the amount you put into your self-employed retirement plan.

Getting more credit for retirement savings: I know that when you're young and in debt, it's hard to put much of your limited cash into savings vehicles you can't access for a while. But any amount you can save will benefit from years of compound growth.

Plus, these tax-favored savings accounts could offer yet another tax advantage. By contributing to them, you might be eligible for the Retirement Savings Contributions Credit, or Savers' Credit.

Because it is a tax credit, it is a dollar-for-dollar offset of any tax you owe. That means you could erase up to $1,000 of your tax liability. You get that maximum one grand amount as long as you contribute during the tax year at least $2,000 to any IRS qualified retirement saving vehicle.

The IRS says this credit is available for money you, or your spouse if y'all file a joint return, put into any of the retirement saving options discussed in this post.

The only downside here is that there are income limits on who can claim the Retirement Savings tax credit. If in 2022 you can't claim the Retirement Savers credit if you make more that the following amounts:

• $34,000 for single and married filing separately taxpayers'
• $51,000 for heads of household filers; and
• $68,000 for married couples filing jointly.

If your earnings don't exceed the credit's caps, be sure you take advantage of this tax break. But remember, you have to contribute to a retirement plan to do so.

You also might find these items of interest:

• IRA contribution, and possible tax deduction, time
• Retirement, pension plan inflation adjustments for 2022
• ABLE accounts offer tax-favored saving help to disabled individuals
• House Ways & Means is latest to want answers about crypto in workplace retirement plans

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