Tax Tip

It’s April -- time to pay your taxes. But what if you could put off paying Uncle Sam until next year, or maybe ten, twenty or even forty years? With tax-deferred retirement savings, you can. The government lets you delay paying taxes on money that you set aside for retirement. So not only will you owe less tax today, you’ll have more money when you retire. Here’s how it works.

Taxes are calculated as a percentage of your income. The more you earn, the more tax dollars you owe. However, you don’t pay taxes on everything you earn. The government lets you deduct, or subtract, some expenses from your income, including money you put into a retirement savings plan. These deductions make your income smaller, which means you’ll pay less in taxes.

Many employers offer their workers a company retirement plan called a 401(k). Under this plan, a fixed amount of money is automatically deducted from each paycheck and put into an investment, like a mutual fund or a money market. You don’t pay taxes on this money -- at least not yet. For example, if you earn $800 every two weeks, you’ll take home about $600 after taxes. But if you put $50 from each paycheck into your 401(k), you’ll pay taxes on only $750. Now your take-home pay will be about $563. That’s $37 less. So a $50 investment only cost you $37.

If your employer doesn’t offer a 401(k), you can set up an individual retirement account, or IRA, through a bank or mutual fund company. Whatever your plan, be sure to stay on top of the rules (the government’s and if you’re saving with a 401(k), you employer’s). There are limits to how much you can put in your account, and if you withdraw money before you turn 59 1/2, you may have to pay a stiff penalty.

Of course tax-deferred doesn’t mean tax-free. You’ll pay tax on those retirement savings when you withdraw the money. But money that would have gone to taxes gets invested in your private account instead. That means there’s more money in the account making more money for you.


Want to learn more about saving for retirement? Check out this online lesson.

For the nitty-gritty on tax-deferred savings, go to www.irs.gov.