Many people ask me what “loopholes” they can use to lower their taxes and how the rich are able to not pay taxes. While I somewhat disagree with these implied questions, I will say that one of the most effective ways to reduce your taxes while growing your assets is through retirement accounts.
In fact, these accounts are so advantageous that the government sets up various contribution and income limitations to prevent people from overusing them. The top 1% almost always try to maximize their retirement accounts so make sure you take advantage of these too!
Employer-Sponsored Retirement Accounts
401(k) Plans
The most common workplace retirement account is the 401(k). This plan lets employees contribute a portion of their paycheck to a tax-advantaged retirement fund. For 2025, the annual contribution limit is $23,000, with an additional $7,500 catch-up contribution for workers age 50 or older.
401(k) contributions must come out of your paycheck so don’t wait until December to start contributing. Ideally you decide how much you want to contribute at the beginning of the year, divide that by the number of pay periods per year and deduct that amount from each paycheck. If you decided midway through the year to start contributing then do the same except divide by the remaining pay periods of the year.
Employer Matching Contributions
Many employers offer a matching contribution in which the employer contributes to the 401(k) based off how much the employee contributes. Typically it is a 100% match and has a maximum based off a percentage of the employee’s salary, usually 3-6%. The match does not impact the employee’s contribution limit.
In virtually all scenarios you should maximize the employer’s matching contribution. Getting what is essentially an immediate and guaranteed 100% return into a tax advantaged account is worth whatever complexities there are in setting up this account. Even in a worst case scenario where you’re forced to take an early withdrawal, the early withdrawal penalty is 10% so you’d still be up if you got a 100% match.
Traditional vs. Roth 401(k)
Many 401(k) plans allow you to choose between Traditional and Roth options. As with all retirement plans, they both grow tax-free meaning that any capitals gains, dividends earned and interest earned within the accounts are not taxed. The difference between these two are as follows:
- Traditional 401(k): Contributions towards the account are tax deductible, but you’ll pay taxes when you withdraw funds.
- Roth 401(k): Contributions towards the account are not tax deductible, but withdrawals in retirement are tax-free.
Which should you choose?
This is a complicated question with surprising results. If you’re able to invest it for at least 20 years then you should almost always be choosing a Roth. The reason is that you can expect (but not guarantee) the investment be about four times its original value when investing for 20 years creating significant ordinary income when withdrawn. There are some scenarios where you may end up paying more tax than if it was in a regular brokerage account because the gains may only be subject to long-term capital gains!
If you won’t be investing that long then you should consider your current marginal tax rate and expected marginal tax rate during retirement. If you expect your marginal tax to be much higher now than during retirement then you should contribute to a traditional account. If less or about the same taxes during retirement then you should pick a Roth. At the end of the day, I just want people to contribute more to retirement and either one of these is a good choice!
Nonprofit and Government Versions
Employees of nonprofits typically have access to a 403(b) plan, while government employees may participate in a 457(b). Both are extremely similar to 401(k)s in how they work with identical contribution limits, catch-up rules, distribution requirements, etc. 457(b) plans often have more flexible withdrawal options for those who leave employment before retirement age.
Catch-Up Contributions and 2026 Roth Rule
As stated earlier, workers age 50 and older are allowed a catch-up contribution of $7,500 for 401(k), 403(b) and 457(b) plans. Starting in 2026, a new rule from the SECURE 2.0 Act will require that if you earned more than $145,000, your catch-up contributions must be made as Roth contributions. Please note that there are no income limits to contributing to a Roth 401(k) (as opposed to a Roth IRA which I will mention later in this article).
Individual Retirement Accounts (IRAs)
Outside of workplace plans, individuals can contribute to IRAs. As with 401(k) plans, these are also available as either a Traditional or Roth account. For 2025, the IRA contribution limit is $7,000, plus a $1,000 catch-up if you’re 50 or older. These accounts are self-managed so make sure you’re buying qualified investments after you’ve moved cash into these accounts. There is no point in an IRA if you just leave cash in there!
Unlike with 401(k) plans, the contributions do not have to be made throughout the calendar year. The deadline is instead April 15th of the following year. For 2025, you’d have until April 15th 2026 to contribute to either IRA. Filing an extension on your individual tax return does not extend this deadline. If contributing past the calendar year then make sure the contribution is for the year prior as it’s very easy to mistakenly mark the contribution for the wrong year.
Traditional IRAs do not have an income limitation. Roth IRAs on the other hand do have an income limitation when directly contributing to one. For 2025, the contribution limit starts phasing out at $150,000 MAGI (modified adjusted gross income) and ends at $165,000 when filing single or head of household. For married filing joint the phase out starts at $236,000 and ends at $246,000. Filing separately the phase-out starts at $1 and ends at $10,000, so you basically can’t directly contribute when filing separately. There is a workaround this limitation known as a Backdoor Roth Conversion.
Backdoor Roth Conversion
This legal workaround effectively allows one to contribute to a Roth IRA even if their MAGI disallows them to directly contribute to one. The process involves contributing to a traditional IRA and then converting those funds into a Roth IRA.
For example, if you’re filing single, have an MAGI of $200,000, aren’t offered any employer retirement plans and wanted to contribute the maximum amount to a Roth IRA then you can contribute $7,000 to a traditional IRA and then transfer the $7,000 to a Roth IRA account. During tax time you’ll deduct the $7,000, but also recognize the $7,000 transfer as income which effectively wash each other out. Do note that legislation is well aware of this with many politicians wanting to close this workaround.
Can you contribute to both a 401(k) plan and an IRA?
Yes, you can contribute to both a 401(k) and an IRA in the same year, however there is an income limitation that prevents the traditional IRA from being deductible when merely being offered an employer retirement plan.
For 2025, the deduction begins to phase out once your MAGI exceeds $77,000 and fully phases out at $87,000 for single and head of household filers. When married filing jointly it starts at $123,000 and ends at $143,000. If only one spouse is covered by a workplace plan, the noncovered spouse can deduct contributions until joint income reaches $240,000. Filing separately starts at $1 and ends at $10,000, effectively preventing them from taking advantage of this.
I’d like to emphasize that you are still able to contribute to a traditional IRA even if your MAGI exceeds these limits, however you won’t be able to deduct the amount you contribute and will still be taxed when the money is withdrawn.
Self-Employed Retirement Plan Options
Business owners and freelancers have several powerful ways to save for retirement while reducing taxable income. Each plan has different contribution limits and administrative requirements.
SEP IRA (Simplified Employee Pension)
A SEP IRA is one of the easiest retirement accounts for self-employed individuals to establish.
- Contribute up to 25% of net earnings from self-employment (maximum $69,000 for 2025).
- Contributions are made by the employer only, no separate employee deferrals.
- Minimal paperwork and no annual IRS filing requirement.
If you have employees then you must contribute the same percentage for them as for yourself. For this reason it’s not too common when there are employees, but can be very beneficial when there are none. The deadline is April 15th of the following tax year and is extended if an extension is filed for the individual return.
Solo 401(k)
For sole proprietors and owner-only businesses, the Solo 401(k) offers both high contribution limits and flexibility.
You can contribute as follows:
- As an employee of your business: Up to $23,000 (plus $7,500 catch-up if 50+).
- As the employer: Up to 25% of compensation, up to $69,000, reduced by the amount contributed as an employee (also plus $7,500 catch-up if 50+).
Solo 401(k)s can include Roth options and even allow plan loans. Once assets exceed $250,000, Form 5500-EZ must be filed annually. Finally, please be aware that the employee portion must be deducted from your paycheck which must be paid out within the calendar year. Good tax planning is essential when going this route.
SIMPLE IRA
A SIMPLE IRA (Savings Incentive Match Plan for Employees) can be a solid alternative to a 401(k) plan for small businesses with 100 or fewer employees.
- Employees can defer up to $16,000 in 2025, plus a $3,500 catch-up for those 50 and older.
- Employers must either match up to 3% of compensation or contribute 2% for all eligible employees.
SIMPLE IRAs are easy to administer and affordable, though contribution limits are lower than those for 401(k)s.
Keogh Plans
Keogh Plans (also called HR-10 plans) are older retirement plans for self-employed individuals. They can be structured as defined contribution or defined benefit plans offering potentially higher contribution limits, but with stricter administration. While less common today, Keoghs can still be useful for professionals seeking very high retirement savings limits.
Retirement Account Penalties
Retirement accounts come with strict rules to maintain their tax advantages and violations can trigger penalties. One of the most common is the 10% early withdrawal penalty on distributions taken before age 59½, in addition to any income tax owed. Another penalty is the 6% excise tax on excess contributions, which applies each year until the overcontribution is corrected.
Other penalties can be more severe. Failing to take required minimum distributions (RMDs) after age 73 can trigger a 50% excise tax on the amount that should have been withdrawn. Engaging in prohibited transactions (such as borrowing from your account or using plan assets for personal benefit) can jeopardize the account’s tax-advantaged status in addition to civil penalties. And for Solo 401(k)s with over $250,000 in assets, failing to file Form 5500-EZ can result in daily fines. Staying aware of these rules helps ensure your retirement savings grow without costly mistakes.
Early Withdrawal Exception
Finally, I’d like to briefly go over some of the qualified withdrawals that are exempt from the early withdrawal penalty:
- Qualified Education Expenses (IRA only): Use funds for tuition, fees and related expenses for yourself, your spouse or your children.
- Disability (IRA and 401(k)): If you become totally and permanently disabled, you may qualify for penalty-free withdrawals.
- Medical Expenses (IRA and 401(k)): Withdrawals to pay unreimbursed medical expenses exceeding 7.5% of your AGI may be penalty-free.
- Health Insurance (IRA and 401(k)): If you’re unemployed and receive federal or state unemployment benefits for 12 consecutive weeks, you can use funds to pay for health insurance premiums.
- SEPP (Substantially Equal Periodic Payments) (IRA and 401(k)): Allows fixed distributions based on life expectancy. Once you start a SEPP you generally need to take the distribution every year and can no longer contribute to a retirement plan without incurring retroactive penalties. Talk to a tax advisor before considering this.
- First-Time Home Purchase (IRA only): Withdraw up to $10,000 to buy, build or rebuild your first home. Certainly not enough to cover a down payment nowadays, but it could help!
- Emergency Personal Expense (IRA and 401(k)): Only $1,000 per year. This is one of the situations where I’m reading the tax code and think to myself why they even bother doing this. Do they think this is a lot to us? Hopefully it’ll get increased in the future.
- Forced to Withdraw due to a Court Order?: The IRS frequently denies early withdrawal penalty abatement for this reason, however several court cases have both agreed and disagreed with their position. Feel free to contact me if you’re in this situation.
Note that while these exceptions may waive the 10% early withdrawal penalty, ordinary income tax will still apply unless the funds are from a Roth account with qualified distributions.
Final Thoughts
While it may not be glamorous to have money stored away in a retirement account, it is statistically one of the most effective ways to grow wealth. These accounts inherently incentivize holding your investments which also happens to be a great investment strategy.
For reference, a $10,000 investment that receives a 7% return would only be $10,700 after a year, but after a decade it’d be $19,671 and after 30 years it’d be $76,122! If that’s in a retirement account then that gain of $66,122 is not taxed and if it’s in a Roth account it’s not taxed at all! Make sure to start putting money into retirement now and your future self will greatly appreciate it!
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