It’s no secret that the most common retirement savings option for employees is the 401(k). The majority of companies rely on this to make it easier for them to provide a solution for their people while making it easy to administer as well. So as a new generation comes into the workforce and the stockmarket slides into a Bear market, let’s look at some basics for 401(k) success. It’s still never too early to begin paving your road to a comfortable retirement by contributing to an employer-sponsored 401(k) account.
The maximum amount workers can contribute to a 401(k) for 2019 is $19,000 if they’re younger than age 50. Workers age 50 and older can add an extra $6,000 per year in “catch-up” contributions, bringing their total contributions for 2019 to $25,000. Contributions to a 401(k) are generally due by the end of the calendar year.
A 401(k) is an employer-based retirement savings account that you fund through payroll deductions before taxes have been taken out. Those contributions lower your taxable income and help cut your tax bill. For example, if your monthly income is $4,500 and you contribute $1,000 of that to your 401(k), only $3,500 of your paycheck will be subject to tax. While the money is in your account, it is sheltered from taxes as it grows.
The money is usually invested in a variety of stock and bond funds. The average 401(k) plan offers 19 funds, and typically nearly half of plan assets are invested in U.S. stock funds and target-date funds, which change their asset allocation to become more conservative over time.
Many employers also match employees’ contributions up to a certain percentage of salary. Some companies even contribute to workers’ accounts regardless of whether the employees contribute their own money. On average, companies contributed 4.8% of an employee’s pay to the employee’s 401(k) account, according to the Plan Sponsor Council of America.
How Much Should You Save in a 401(k)?
Stuart Ritter, a certified financial planner with T. Rowe Price, recommends that workers save at least 15% of their income for retirement, including any employer match. If your employer contributes 3%, for example, then you would need to save an additional 12%.
The tax-deferred growth of a 401(k) can help build a sizable nest egg. For example, a 25-year-old who contributes $5,500 a year to a 401(k) and has an annual return of 6% will accrue a nest egg of $902,262 at age 65. If instead he or she is in the 22% tax bracket and saves the same amount in taxable account, assuming the same return, the balance after 40 years is $643,500.
Is a 401(k) Right for You?
According to Melissa Brennan, a certified financial planner in Dallas, a 401(k) works best for someone who anticipates being in a lower tax bracket at retirement than they’re in now. For example, someone in the 32% or 35% tax bracket may be able to retire in the 24% bracket. “In that case, it makes sense to save on a pretax basis and defer income taxes until retirement,” Brennan says.
Employers have been increasing tax diversification in their retirement plans by adding Roth 401(k)s. These accounts combine features of Roth IRAs and 401(k)s. You can withdraw contributions and earnings tax- and penalty-free if you’re at least age 59½ and have owned the account for five years or more.
If you or your clients have any tax issues or problems with the IRS/State or other federal tax problems, please feel free to contact me directly at (909) 570-1103 or by email at Carlos@HealthcareTaxadvisor.com
Carlos Samaniego, EA
Enrolled Agent
Licensed by The Department of Treasury to represent taxpayers
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