We all know that the earlier we save for retirement, the better. Saving taxes at the same time is just a bonus when you contribute to a tax-advantaged retirement plan. If your employer offers a 401(k) plan, contributing to that is likely your best first step to building up your nest egg. If you’re not already contributing the maximum allowed, consider increasing your contribution rate between now and year-end. Contributing your max now can have a significant impact on the size of your account at retirement because of tax-deferred compounding (or tax-free for Roth accounts).
A traditional 401(k) offers many benefits:
- Contributions are pretax, reducing your modified adjusted gross income (MAGI), which can also help you reduce or avoid exposure to the 3.8% net investment income tax.
- Plan assets can grow tax-deferred — meaning you pay no income tax until you take distributions.
- Your employer may match some or all of your contributions pretax.
For 2017, you can contribute up to $18,000. So if your current contribution rate will leave you short of the limit, try to increase your contribution rate through the end of the year to get as close to that limit as you can afford. Keep in mind that your paycheck will be reduced by less than the dollar amount of the contribution, because the contributions are pre-tax so income tax isn’t withheld.
If you’ll be age 50 or older by December 31, you can also make “catch-up” contributions (up to $6,000 for 2017). So if you didn’t contribute much when you were younger, this may allow you to partially make up for lost time. Even if you did make significant contributions before age 50, catch-up contributions can still be beneficial, allowing you to further leverage the power of tax-deferred compounding.
Employers can include a Roth option in their 401(k) plans. If your plan offers this, you can designate some or all of your contribution as Roth contributions. While such contributions don’t reduce your current MAGI, qualified distributions will be tax-free.
Roth 401(k) contributions may be especially beneficial for higher-income earners, because they don’t have the option to contribute to a Roth IRA. On the other hand, if you expect your tax rate to be lower in retirement, you may be better off sticking with traditional 401(k) contributions.
Finally, keep in mind that any employer matches to Roth 401(k) contributions will be pretax and go into your traditional 401(k) account.
Planning for the future is complicated, but there are strategies that can both reduce taxes and help you save for retirement. If you have questions about how much to contribute or the best mix between traditional and Roth contributions, JLK Rosenberger can help. For more information, call us at 949-860-9902 or click here to contact us.