How To Trim Taxes Using Your Retirement Plans

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It's always good to build your retirement accounts. Now those contributions also can help many taxpayers avoid new taxes.

The new levies are aimed at high-income taxpayers. A top tax rate of 39.6% applies to individuals with taxable income over $400,000 ($450,000 for married couples filing joint returns). Here's what the new levies do:

•Everyone in the 39.6% tax bracket also owes 20% on long-term cap gains and dividend income. Others pay a max of 15%.

•The new tax law cuts the value of personal exemptions and certain itemized deductions.

Those provisions kick in for taxpayers with adjusted gross income ( AGI ) over $250,000 for singles, over $300,000 on joint returns.

•There's also a 3.8% Medicare surtax. It is applied to your net investment income, with limits.

You're vulnerable if your modified AGI tops $200,000 ($250,000 for couples). This MAGI usually is the same as your AGI.

Reducing your AGI also will reduce your taxable income, making the overall bite less painful.

One way to reduce your AGI is to maximize pretax contributions to retirement plans such as 401(k)s and 403(b)s. You can defer up to $17,500 of earnings this year, or up to $23,000 if you're at least age 50.

Most people can take advantage of this strategy because few workers max their retirement plan contributions. In 401(k) plans run by Fidelity, for example, only 9.4% of plan members who contribute to their accounts reached the upper limit.

And 7.9% of all plan members -- whether or not they contribute -- did so. Among workers 55 or older, 16.0% of contributors maxed their 401(k) deferrals, while 13.2% of all participants hit the ceiling.

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Professionals and entrepreneurs may find even more tax shelter. Solo 401(k)s and simplified employee pensions (SEPs) permit deductions up to $51,000 this year.

At the other end of the scale, deductible IRA contributions also can trim AGI. The max for 2013 is $5,500, $6,500 if you're 50 or older.

Deducting your contributions is difficult if you participate in an employer's retirement plan. You face income-based cutoffs, with relatively low thresholds.

But there is room for more IRA deductions. According to the latest IRS data, from 2008, only 50% of traditional IRA contributors made maximum contributions.

Sixty percent is more typical now, says Sarah Holden, senior director of retirement and investor research at the Investment Company Institute. So many investors likely can put more into their IRAs, perhaps reducing their AGI.

What if you are already maximizing 401(k) and deductible IRA contributions? Another strategy involves a Roth IRA conversion.

Say a hypothetical Ed Park is married. The Parks expect taxable income this year of $180,000.

The 28% tax bracket goes up to $223,050 of taxable income for couples. So Park can afford to convert up to $43,050 of his IRA to a Roth without putting himself into a higher tax bracket and also exposing himself to the new, additional taxes on high-bracket taxpayers.

The Parks would owe roughly $12,054 tax on the conversion. But they will still be in the 28% bracket.

And after five years and reaching age 59-1/2, their Roth withdrawals will be tax-free. Also, they'll cut future taxable IRA distributions, which might be at higher rates.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Mutual Funds

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