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Money Matters – Mid-Year Tax Planning: Retirement Plan Contributions

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420x316-grad-lee Dee Lee
Dee Lee is a Certified Financial Planner who received a diploma in...
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BOSTON (CBS) – It’s midyear and this is a good time to review your retirement accounts. The contribution limits for 2011 for a 401(k), a 403(b) and a 457 plan is $16,500. These limits increase with the rate of inflation and did not increase last two years.

And if you are 50 or reach that magic age this year, you can use the catch up provision and contribute an additional $5,500 to your account if your employer has instituted a catch up provision in the plan. Also, both the 403(b) and 457 plans have an additional catch up provision as you near retirement age.

For most individuals it is impossible to come with $16,500 to stash away in a retirement plan annually. Less than 10% of workers are able to do so and they all work in Silicon Valley in California. If you are not contributing the maximum to your retirement account, consider increasing your contribution level to at least what your employer may be matching.

Then consider increasing your contribution level every six months or share every raise with your retirement plan. By increasing your contributions slowly, you learn to live with the smaller take home pay. And if you don’t have it in your pocket, you are not apt to spend it.

There is a big tax advantage in using your employer’s retirement plan. The dollars you contribute are going in before income taxes are withheld from your salary. You will still owe Social Security and Medicare taxes though.

For example, if you are able to contribute $3,000 to your 401(k), it doesn’t really cost you $3,000 for you will not owe income tax on that $3,000. So if you are in the 25% tax bracket the real cost of contributing the $3,000 is $2,250 plus the Social Security and Medicare taxes of $170.

And while those dollars are in your account, they are growing tax deferred. Tax deferred compounding is the Eight Wonder of the world. Forget the Taj Mahal – most of us will never see it any way.

For 2011, all IRA contributions are limited to $5000 and if you are over 50, you can add a catch up contribution of another $1000 to the account. That’s a regular IRA, Spousal IRA, Non-deductible IRA and Roth IRA.

Now there are income limits associated with IRAs and you must have earned income of at least the amount of the contribution. So if you earned $10,000 and are over 50 you are good to go to put away $6000 in your IRA. But if you earned only $4,000 then you are limited to the $4,000 for your contribution.

If you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA is reduced (phased out) if your modified adjusted gross income (AGI) is:

  • More than $56,000 but less than $66,000 for a single individual or head of household, or
  • More than $89,000 but less than $109,000 for a married couple filing a joint return or a qualifying widow(er)
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