Tax Advantages of a Retirement Plan
Tax-Deferred Contributions
Saving for your dreams may cost you less than you think. Because your contributions come out of your paycheck before being taxed, you pay less in current income taxes. At the same time, you are not only saving tax dollars, but those dollars are being invested.
Looking at the hypothetical example below, John is saving four percent of his annual income, or $67 per month. His contribution is deducted from gross wages before being taxed. This reduces his current taxable income. Although John is saving $67, his take-home pay is reduced by only $57 as a result of his tax savings.
It costs only $57 to save $67.
John's annual income: $20,000 (single, withholding 2)
| No Savings | Savings | |
| Gross monthly pay | $1,667 | $1,667 |
| Monthly contribution | $0 | $67 |
| Taxable income | $1,667 | $1,600 |
| Estimated taxes * | $228 | $218 |
| Take home pay | $1,439 | $1,382 |
*Social Security/Medicare taxes are calculated on your gross earnings
Tax-Deferred Earnings
In addition to your pre-tax contributions, any earnings in your employer's retirement account are also tax-deferred. That means there is no initial tax bite to reduce your contributions and any earnings. As a result, compound earnings may accumulate more quickly than if they were in a taxable account.
Although you will pay taxes on the money you eventually withdraw from your account, you'll only pay taxes on each amount as it's withdrawn.3 Good financial planning and tax advice can help you reduce the tax burden, while the rest of your participant account balance has the potential to continue to accumulate.
Check out our paycheck calculator to see how contributing more to your retirement plan may not make much difference in your take-home pay.
Take a look at this hypothetical example.1 If you contribute $100 per month ($1,200 per year), tax-deferred, assuming a hypothetical gross annual rate of return of 8% for 20 years, you would accumulate $58,902.2
Since it's tax-deferred, taxes will be taken out upon withdrawal.3 If you were to withdraw it in one lump sum, you would be left with $44,177 (assuming a 25% tax bracket). Assuming the same hypothetical 8% gross annual rate of return, that same $100 invested after-tax over 20 years would accumulate to only $34,873 because any earnings are taxed.4
1This hypothetical example is intended only to illustrate the advantage of tax deferral and does not project the actual performance of any specific investments. Actual results and principal values will fluctuate.
2The tax deferred results do not reflect the deduction of any combined state or federal tax obligations at retirement and assume no interim distributions.
3Withdrawals are subject to ordinary income taxes and, if taken prior to age 59½, a 10% income tax penalty may also apply. Tax-deferred with taxes taken out represent the lump-sum surrender value at the end of the period less taxes at an assumed federal tax rate of 25%.
4The taxable investment results are net of an assumed federal tax rate of 25% and assume no interim distributions. Lower maximum tax rates on capital gains and dividends make the return for the taxable account more favorable, which reduces the difference in performance between the accounts. You should consider your personal financial circumstances (current and anticipated), any changes in tax rates and tax treatment of investment earnings when making investment decisions, as these may further impact the results of the comparison.
This information is written in connection with the promotion or marketing of the matter(s) addressed in this material. This information cannot be used or relied upon for the purpose of avoiding IRS penalties. These materials are not intended to provide tax, accounting or legal advice. As with all matters of a tax or legal nature, you should consult your own tax or legal counsel for advice.
Before investing, you should carefully consider the investment objectives, risks, charges and expenses of the mutual funds or The Hartford's group variable annuity products and funding agreements, and their underlying funds. For fund and product prospectuses and/or a disclosure document containing this and other information, contact your financial professional or visit our website. Read them carefully.
RPS 7394
