Saving for retirement can seem simple, but there are a number of considerations in order to save smarter. We’ll go over the basics of the 401k, traditional IRA and Roth IRA contributions and distributions over the next few months. Today we’ll cover 401k plans.
Many people contribute to employer-sponsored retirement plans throughout the year, with the most common being a 401k plan. The IRS has set 2021 contribution limits of:
- $19,500 for under 50
- $26,000 for those 50 and older ($6,500 catch-up limit)[i]
For every dollar contributed to a 401k plan, taxable income is reduced by the same amount, up to the limits above. These contributions are considered tax deferred. When distributions are made, they will be taxed at the tax rate set forth by the IRS at the time of distribution.
A potential disadvantage in contributing to a 401k is that distributions can only be made in the following circumstances:
- You die, become disabled, or otherwise have a severance from employment.
- The plan terminates and no successor defined contribution plan is established or maintained by the employer.
- You reach age 59½ or experience a financial hardship.
Any distributions taken outside of these situations are subject to an additional 10% tax in addition to the income tax rate. Therefore, if you think that you may need or want to access some of your retirement savings early, consider saving a portion of your savings in a brokerage account, money market account, or savings account.
These are just the basics of contributing to a 401k plan. There are many more rules that govern these types of plans. If you’re looking at getting started saving, preparing for regular distributions, or need an unplanned withdrawal, we can help you through the tax implications of your decision.
For more information check out the IRS 401(k) Resource Guide
[i] Source: IRS.gov, 401(k) Resource Guide – Plan Participants – General Distribution Rules