There’s a lot to like about a 401(k) plan. Whether you already participate in your employer’s plan or you’re just now thinking about joining, reviewing the benefits as tax time approaches is a smart idea.
The Pretax Advantage
When you participate in a traditional 401(k) plan, your contributions to the plan are taken out of your pay before income taxes are deducted, thus lowering your taxable income. Your plan contributions and any earnings grow tax deferred until you withdraw them, typically at retirement, when you may be in a lower tax bracket than you are now. And with automatic payroll deduction, contributions to your employer’s plan come out of your paycheck before you are tempted to spend the money.
The Benefits of a Match
Most employers match employee contributions up to a certain percentage. That’s like getting “free money.” All the funds you contribute to the plan belong to you right from the start. Over time, all your employer’s contributions will also belong to you, based on a vesting schedule outlined in your employer’s plan documents. Remember, the sooner you start contributing to your plan, the longer you’ll have to benefit from compounding – earning interest on both contributions and earnings.
2021 Tax Deduction
You have until December 31, 2021, to make contributions to a 401(k) to lower the taxable income on your 2021 income tax return, so consider contributing as much as possible to reap the tax benefit. Your maximum contribution limit in 2021 is up to $19,500 to a 401(k) plan. If you’re age 50 or older, you can make an additional “catch-up” contribution of $6,500, for a total of $26,000.
A Word About Roth 401(k)s
Your employer may also offer a Roth 401(k) option. Roth contributions are made with after-tax funds, so withdrawals of earnings are tax-free, provided all requirements are met. A Roth 401(k) may be a good option if you expect to be in a higher tax bracket after retirement.
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