Investing money into a tax-advantaged retirement plan can benefit you by reducing taxes and saving more money for retirement. If your employer offers a 401(k) or Roth 401(k), contributing to this plan can help build substantial savings.

If you’re not investing the maximum amount allowed, you should consider increasing your investment.

Taking advantage of tax-deferred compounding (in traditional or Roth accounts) can greatly impact the growth of your retirement savings. An employer 401(k) plan allows an employee to elect to have a certain amount of pay deferred and be eligible for an employer-paid match and/or profit-sharing on the employee’s behalf. The employee contributions for 2023 will be limited to $22,500 ($20,500 in 2022). Individuals age 50 or older by year-end may make an additional “catch-up” contribution in 2023 of $7,500 ($6,500 in 2022). This means individuals 50 or older can contribute a total of $30,000 in 2023 ($27,000 in 2022).

Traditional 401(k)

Traditional 401(k) contributions are pre-tax, which means your modified adjusted gross income (MAGI) is reduced.  This can help reduce or eliminate having to pay the 3.8% net investment income tax. Your investment in your traditional 401(k) can continue to grow tax-deferred, this means you will pay no income tax until you take withdrawals from the plan. Your employer may match your contributions pretax. If you have already been investing in a 401(k) plan, take a look at how much you are contributing. For 2023, look into increasing your contributions to get as close to the $22,500 limit ($30,000 if age 50 or older) as your cash flow allows. Your net paycheck will be reduced by the amount of the 401(k) deferral and income tax is not withheld.

Roth 401(k)

Employers may also offer a Roth 401(k) plan. If your employer offers this plan, you may elect to have all or some of your payroll deferrals treated as Roth 401(k) contributions. While these contributions will not reduce your MAGI, the qualified distributions when you retire are tax-free.

Roth 401(k) plans may be highly beneficial for high-income earners, because they may be ineligible to contribute to a Roth IRA. If your AGI exceeds certain amounts, your ability to contribute to a Roth IRA is reduced or eliminated.

Whether you are wondering how much you should contribute to a 401(k) plan or how to best mix traditional and Roth 401(k) contributions, contact your tax professional at Wegner CPAs to ensure you’re getting the maximum benefit out of your retirement savings.