Saving for retirement through a retirement savings plan (PER) not only helps in building a nest egg but also offers tax deductions that lower taxable income. This fiscal advantage, however, benefits only those who are taxable; non-taxpayers should consider alternative investments. The degree of tax savings from a PER correlates with one’s marginal tax rate, making it most beneficial for higher-income households. Additionally, while contributions reduce taxes now, withdrawals during retirement are subject to regular income tax rules, warranting careful planning to avoid excessive taxation.
Save for your retirement while simultaneously reducing your income tax: this dual benefit is the key advantage of a retirement savings plan (PER). But how can you determine your tax savings?
Contributing to a retirement savings plan allows you to lower your taxable income. More specifically, this translates into a tax deduction. It’s a significant tax incentive provided by the government in exchange for locking away your money until retirement. Thus, investing in a PER at the end of 2024 will decrease your taxable income for that year, ultimately helping to lower the taxes owed in 2025 on your 2024 earnings. That’s the basic premise. Now, let’s delve into the details.
Who benefits from tax deductions with a PER?
Establishing a PER to reduce your taxes requires you to be taxable! This is obvious, yet theoretically, any banker or financial advisor should remind you of this before recommending such a product. If you are not subject to income tax and are considering opening a PER, it is advisable to forgo the tax deduction or opt for other investment options without restrictions (life insurance, savings accounts, PEA, etc.).
Which is better for retirement preparation: life insurance or a PER?
Taxes and PER: How much can you save?
The tax benefits of a PER vary from person to person! As mentioned earlier, there are no savings for a non-taxable household. Additionally, the tax advantage increases according to your tax rate.
Specifically, it depends on your marginal tax rate, or TMI. What does that mean? The income tax scale is progressive: the first portion of income is taxed at 0%, the second portion at 11%, and it rises to 30%, 41%, and finally 45% for individuals whose annual income per share exceeds 160,000 euros.
The TMI is not your overall tax rate, but rather the rate applied to the higher portion of your income. When you contribute to a PER, the tax deduction reduces this upper portion of your income. Therefore, to assess how much a retirement savings contribution benefits you, it all hinges on the tax rate applied to that higher portion.
Key point. The tax deduction for retirement savings is primarily advisable for households within the “upper brackets,” from 30% to 45%.
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What is the tax impact upon retirement?
While you receive a tax benefit upon contribution, you will face taxation upon withdrawal. The tax deduction available for PER contributions is essentially a deferral of taxation. You lower your income tax while saving during your working years; however, the government collects its due when you retire.
When you retire and start withdrawing from your PER, the amounts taken out will be subject to the standard income tax scale, just like earnings from work or retirement pensions, regardless of whether you choose to receive the funds as a lump sum or as an annuity.
One important note: the withdrawn savings are taxed according to the standard scale, while the gains generated from those savings are subject to a flat tax (12.8% income tax). Therefore, if you decide to withdraw capital, it is advisable not to take out everything at once; instead, staggering withdrawals over several years is recommended to avoid a sudden increase in tax liability.
Does this exit taxation negate the tax advantage of the PER? Not if you are betting on a decline in your income during retirement, which would consequently lead to a lower tax liability.
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