Easiest Way to Reduce Your Tax Liability

No one wants to pay more taxes than what is required by law. There is one piece of advice that can apply to most working taxpayers, is to increase pre-tax retirement contributions. Increasing contributions to a pre-tax 401K, simple IRA, or traditional IRA reduces the income that is subject to federal and state income tax. The maximum employee contribution for a 401K just increased to $19,500 a year, so now there is more flexibility in this strategy than before.

There are tax consequences when withdrawing pre-tax retirement funds. Distributions are subject to federal and state income tax, and a 10% penalty can be applied if withdrawing funds before age 55.

If you are taxed on distributions, what is the benefit to contributing to a pre-tax retirement account? Taxpayers are in higher tax brackets during working years, therefore contributing to retirement accounts causes a larger deduction. During retirement years the distributions occur in lower tax brackets, therefore less of a tax burden occurs. Receiving a larger tax deduction versus the tax burden on distributions is the advantage. With perfect planning there are situations where taxpayers may not pay any income tax on the distributions. 

This is article is purely from a tax perspective. A great retirement portfolio consists of both pre-tax and post-tax retirement accounts. Every scenario is different, therefore this general advice cannot be applied directly to your situation and is not intended to be tax advice. If you have concerns about retirement contribution deductions, it is best practice to consult with a tax professional.