You can save more for retirement next year using tax-advantaged accounts, thanks to a boost in the maximum 401(k) contribution rate by the IRS. The maximum rate increases by $500 to $18,500, which is the first increase in three years. Those aged 50 or older can still contribute an additional $6,000 on top of that amount.
This is good news, because a 401(k) is one of most potent tools in your retirement arsenal. It offers many benefits over other forms of saving, including:
Pretax income of $18,500 invested over 30 years with 6 percent annual cumulative interest will grow to $111,901.92. That’s compared with $67,588.76 of the same amount of income invested after being taxed at the highest rate. While you’ll owe tax on 401(k) withdrawals after retirement, you may be able to manage your 401(k) withdrawals to fall into a lower income bracket.
You may opt to make your contributions to a 401(k) as a Roth investment, meaning you invest post-tax income, but you can withdraw from your Roth tax-free during retirement. A mix of traditional and Roth accounts will give you flexibility to manage your income tax rate during retirement.
“401ks have required minimum distributions once you reach 70 ½. If you have a Roth 401k, there are no required minimum distributions.” – Ren Cicalese III, CPA, MST
“Be aware of income limitations that may preclude any Roth contributions.” – Rich Middleton, CPA
Many companies offer to match the first few percentage points of their employees contributions to a 401(k). Even if you can’t max out your contribution, you should try to invest up to your company’s match limit. Otherwise, you’re just leaving money on the table.
While 401(k)s have great utility, they come with a few downsides. Any withdrawals made before age 59 1/2 are assessed a 10 percent penalty fee, in addition to being taxed as regular income during the year they are withdrawn. Any investments in 401(k)s are also limited to a few choices set by your employer’s retirement plan, so a limited number of conventional investment options in mutual funds is one of the trade-offs of using a 401(k).
“Some employer plans have the option for hardship distributions, which may qualify for a penalty-free distribution. For instance, if you become totally disabled the penalties will be waived on an early distribution.” – Ren Cicalese III, CPA, MST
If you are self-employed, the potential maximum retirement contribution is increased to $55,000 for 2018. – Mike Engleman, CPA
The federal retirement safety net system, Social Security, also gets a boost during 2018. The average estimated monthly benefit paid to retirees in 2018 will be $1,404 in 2018, up from $1,377 in 2017. The maximum amount of wages subject to Social Security taxes rises to $128,700 in 2018, up $1,500.
As always, contact Alloy Silverstein for guidance on your individual situation.
Empowering business owners and individuals in South Jersey and Philadelphia to feel confident through proactive accounting and advisory solutions.
