If so, take advantage of it and save for retirement. If your employer offers a 401(k) or Roth 401(k) plan, contributing to the plan is a smart way to build a substantial sum of money for retirement, with tax advantages.
This can be accomplished with a straight 401(k) plan or a Roth 401(k), or a combination of both.
If you’re not already contributing the maximum allowed, consider increasing your contribution rate. Because of tax-deferred compounding (tax-free in the case of Roth accounts), boosting contributions can have a major impact on the size of your nest egg at retirement.
With a 401(k), an employee makes an election to have a certain amount of pay deferred and contributed by an employer on his or her behalf to the plan. The contribution limit for 2020 is $19,500. Employees age 50 or older by year end are also permitted to make additional “catch-up” contributions of $6,500, for a total limit of $26,000 in 2020.
The IRS recently announced that the 401(k) contribution limits for 2021 will remain the same as for 2020.
If you contribute to a traditional 401(k)
A traditional 401(k) offers many benefits, including:
- 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.
If you already have a 401(k) plan, take a look at your contributions. Try to increase your contribution rate to get as close to the $19,500 limit (with an extra $6,500 if you’re age 50 or older) to the extent you can afford it. Keep in mind that your paycheck will be reduced by less than the dollar amount of the contribution, because the contributions are pretax — so, income tax isn’t withheld.
If you contribute to a Roth 401(k)
Employers may also include a Roth option in their 401(k) plans. If your employer offers this, you can designate some or all of your contributions as Roth contributions. While such contributions don’t reduce your current MAGI, qualified distributions from the Roth portion 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. Your ability to make a Roth IRA contribution for 2021 will be reduced if your adjusted gross income (AGI) in 2021 exceeds:
- $198,000 (up from $196,000 for 2020) for married joint-filing couples, or
- $125,000 (up from $124,000 for 2020) for single taxpayers.
Your ability to contribute to a Roth IRA in 2021 will be eliminated entirely if you’re a married joint filer and your 2021 AGI equals or exceeds $208,000 (up from $206,000 for 2020). The 2021 cutoff for single filers is $140,000 or more (up from $139,000 for 2020).
The best mix
Contact your Rudler, PSC advisor if you have questions about how much to contribute or the best mix between traditional and Roth 401(k) contributions. We are available to discuss the optimal tax and retirement-saving strategies for your situation at 859-331-1717.
RUDLER'S TAX MANAGEMENT & PLANNING TEAM
This week's Rudler Review is presented by Evan Kandra, Staff Accountant and Audrey Goetz, CPA, CVA.
If you would like to discuss your particular tax situation, contact Evan or Audrey at 859-331-1717.
Rudler PSC has established a Tax Management and Planning Team, a group of professionals who specialize in tax services. These highly qualified and experienced tax specialists meet on a regular basis to discuss upcoming client engagements, current issues relating to our clients and regulatory changes. Be sure to receive future Rudler Reviews for advice from our tax experts, sign up today !