Maximizing Retirement contribution to reduce Taxable Income

Do you know how to choose among different retirement contributions?

Do you want to reduce your taxable income and get the benefits during your retirement? Most people I talk to are unaware of the retirement accounts’ benefits and which one to choose over another. If you are one of those people, this post is for you.

As always, few disclosures about today’s post before we get started:

• I am not a Lawyer, CPA, or registered financial advisor. I am sharing how I contribute to my retirement accounts, and this might help you make better decisions after learning the reasoning behind my decisions.

• I am writing this particular post based on my subscribers’ request to post about retirement accounts.

• All the analyses I will explain in this post are US-based retirement accounts. You will find some similarities based on your country. If you want me to dive deep based on your location, send me a message. I might consider writing about that in a future post based on the number of subscribers.

Taxable Income

Whenever you are collecting earned income through your job, the Government will collect a portion of your income as TAX to fund the local city, county, or even country-wide public services i.e., public roads, schools, fire services, law enforcement agencies. If you are not paying TAX, those services will be underfunded, and most of us will not have the luxury/privilege to live stress-free. At the same time, the Government will give incentives to business owners, entrepreneurs, or rental property owners since this special group of people typically creates jobs or provides shelter for others. One of the best investments you can make is to learn details about the tax ordinance in your local area and understand how you can help others and save money on taxes. For full transparency, I am not suggesting cheating on taxes, finding tax loopholes. I am suggesting taking advantage of the current tax incentives based on your situation. Look into the current federal tax brackets to understand how much you are taxed for this year, 2025 [1]. The current marginal rates are:

• 35% for incomes over $250,525 ($501,050 for married couples filing jointly).

• 32% for incomes over $197,300 ($394,600 for married couples filing jointly).

• 24% for incomes over $103,350 ($206,700 for married couples filing jointly).

• 22% for incomes over $48,475 ($96,950 for married couples filing jointly).

• 12% for incomes over $11,925 ($23,850 for married couples filing jointly).

• 10% for incomes $11,925 or less ($23,850 or less for married couples filing jointly).

I will make some assumptions about you, like you are in the mid tax bracket of the above table, live in one of the nine no-state income tax states, and you are married filing jointly with a total income of $150K for both of you (monthly income of $12500). You can use the ADP site to calculate your take-home pay based on your information [2].

So, you are paying close to 24.5% of tax on your monthly income. If you are in CA, NY, with high state income tax, you might pay an extra 10% on state income tax. During the tax filing, all of your income, expenses, and deductions are aggregated together, and then you will receive a final figure. The current married filing jointly standard deduction is $30K - you can reduce this amount from your total income of $150K if you go through the standard deduction route [1]. It is easier to see if you can reduce your taxable income, you pay less tax in the end. IRS helps you to save for retirement without paying tax now, up to a certain limit. You are still liable for paying tax later.

Retirement Accounts

There are different types of retirement accounts available that you can open based on your situation and your employer’s choice. I will talk about few most popular plans, but you should read in detail about those plans here [3] based on your situation and interest.

1. 401(k)

This is the most popular plan among all the different retirement account types. The only caveat is that your employer is the one who chooses the specific 401(k), and you either participate in that plan or not. 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts, and most employers also match some portion of your contribution. You will need to understand the matching ratio and go through the 401(k) plan summary document to find out this number. I worked for different companies in the past, some will match 1:1 or 2:1 based on their threshold. This is free money from your employer; if you don’t contribute to/participate in that plan, you will miss out on this free money. Some companies might have a vesting period of like 3 years, where if you leave the company before 3 years, you won’t be able to keep the company match portion. I will make another assumption about your income and a matching portion from your employer.

• Your income is: $100K (the other $50K is your spouse’s income to make it easier to calculate)

• Your company matches 1:1 of your retirement contribution up to 6% of your salary

What does that mean is - if you contribute $6K in your employer’s preferred 401(k), your company will match $6K (this is the free money). If you just do this - you will have total $12K contribution in your 401(k) account.

Step 1: Figure out the maximum amount your company will contribute into your 401(k) plan, then calculate how much you will need to contribute to get that maximum amount.

Although the total taxable income is calculated on a joint level (if you are filing jointly with your spouse), retirement account contributions are on a personal level. The maximum contribution you can make for your 401(k) account is $23500 for the year of 2025 [4].

If you go through this fidelity site [5], you will find out that you can contribute a maximum of $23500 in your retirement account (see the last row of the above screenshot). That leaves you with another $17500 to maximize your contribution. And your retirement account would be $29500, including your employer’s contribution.

Step 2: Calculate the amount you contributed in your 401(k) in Step 1 which is $6K. Then calculate the remaining amount to maximized the limit. $23500 - $6000 = $17500.

Till now, you reduced your taxable income by $23500 by just maximizing your 401(k) retirement contribution. You might ask me what’s the catch - You can’t withdraw this money till your retirement age (close to 60), you will still pay tax at that time, but most likely you will be in a lower tax bracket to pay less tax. Some 401(k) plan allows taking loans due to financial hardship/buying primary residence, or you can even withdraw the whole money by paying tax and a 10% penalty. So it’s not the end of the world.

If your income is $100K per year, most of you might not have enough money to contribute more. So you will be close to done after Step 2. But if you are frugal like me, you might take this to the next step to save & invest even more.

2. ROTH

ROTH retirement account is another special type of retirement account that is slightly different than a traditional 401(k) pre-tax account. The main difference is that you will need to pay the tax for a ROTH account, but you will withdraw money tax-free during your retirement. The question is, why would someone want to contribute to ROTH - because if you are one of the multi-millionaires during your retirement years, you will pay a lot of taxes at that time, and 401(k) has a minimum distribution requirement (RMD). If you become a great long-term investor (you will since you are reading Financial Freedom newsletter now), who will have a lot of unrealized gains, and you don’t want to pay tax on those millions of dollars. The key points of ROTH account are:

• ROTH account will not reduce your taxable income, you contribute after paying tax now

• Your withdrawal will be tax-free during retirement, unlike a traditional pre-tax 401(k) account, which will be taxed

Step 3: If you still have money to contribute in your retirement accounts after step 2, Find out the maximum amount of ROTH contribution you can make based on your income and maximize that amount. It will be $7K for $100K personal income

These are some caveats: if your income is above $150K (for single filing or $236K for married filing jointly) [6], you can’t contribute directly to ROTH IRA account.

3. MEGA BACKDOOR ROTH IRA

This might not work for you if your employer does not support the conversion. The main idea is that you contribute after-tax money to your 401(k) account up to the max limit, and it is converted to a ROTH account afterwards. This is an excellent way to contribute as money as possible to your retirement account. After Step 1 & Step 2, you might have another extra $40,500 to contribute and withdraw it tax free during your retirement years.

Step 3b: If can't use Step 3 and your employer supports MEGA BACKDOOR ROTH IRA, Calculate the total contribution you made after Step 2 including your employer contribution: $29500. Check the second column of the above chart and substract the number: $70K - $29500 = $40500. Contribute this amount to your ROTH account using MEGA BACKDOOR ROTH IRA

Tax-Favored Health Plans

There are a few other ways to save money from taxable income. I am not going into detail about those in today’s post. But check these two out to save even more [8]:

Health Savings Account (HSA)

If you have a high deductible health insurance plan, you can open an HSA account with a qualified custodian. You can contribute pre-tax money up to a certain limit into an HSA account and use the money to pay for your qualified medical expenses. The main idea is that you should not pay taxable money for your medical treatments (for certain kinds of policyholders). The positive side is that you can roll over money to the next year and invest the money too from your HSA account. Talk to your employer’s health insurance plan providers to know the details about high deductible insurance plans, and if it makes sense for you.

Flexible Spending Account (FSA)

Since an HSA account has a limit on how much you can contribute, you can open an FSA account to spend if you have more medical bills to pay. The caveat is that you can’t roll over the balance, so if you put money into your FSA account, you will need to spend it in the calendar year [8].

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Reference

[1] IRS site: https://www.irs.gov/newsroom/irs-releases-tax-inflation-adjustments-for-tax-year-2025

[2] Take home salary calculator: https://www.adp.com/resources/tools/calculators/salary-paycheck-calculator.aspx

[3] Different types of retirement plans: https://www.irs.gov/retirement-plans/plan-sponsor/types-of-retirement-plans

[4] IRS site for 401(k) account: https://www.irs.gov/newsroom/401k-limit-increases-to-23500-for-2025-ira-limit-remains-7000

[5] Fidelity site for retirement contribution limit: https://www.fidelity.com/learning-center/smart-money/401k-contribution-limits

[6] ROTH IRA income requirements: https://www.fidelity.com/retirement-ira/contribution-limits-deadlines

[7] MEGA BACKDOOR ROTH: https://www.fidelity.com/learning-center/personal-finance/mega-backdoor-roth

[8] HSA accounts: https://www.irs.gov/publications/p969