401k plans are a good way to save money for retirement as well as an easy way to reduce your current year taxable income. There are two different 401k plans that employers offer to their employees: a traditional 401k plan and a Roth 401k plan.
Contributing to a Traditional 401K plan through payroll (or as a solo 401k if you are a self-employed individual) is generally done using pre-tax deferrals which reduce your taxable wages/income. That money grows tax deferred within the plan and is taxed as ordinary income when you take withdrawals out of the 401K.
You can make employee deferrals up to $19,000 in 2019 towards your 401k plan; for anyone over the age of 50 they can fund an additional $6,000 for the year (i.e., referred to as the “catch up”). Another benefit is that some employers will match a portion of your 401k contributions up to a certain dollar amount (generally it’s a percentage of your annual compensation).
Different from a traditional 401k plan, money that is contributed to a Roth 401k Plan goes in “after tax”. That money grows also tax deferred within the plan BUT is “Tax Free” when you take withdrawals out of the Roth 401k. Roth 401k contributions are a good alternative for employees who have a high income because they are unable to directly fund a Roth IRA (due to AGI phase-out limitations). The deferral limits for the Roth 401k are the same as the traditional 401k.
The ability to make a Roth IRA contribution in 2019 will be reduced if your adjusted gross income (AGI) in 2019 exceeds:
- $193,000, and you file as married filing jointly, or
- $122,000, and you file as a single taxpayer
These AGI limitations do NOT apply to Roth 401k plans. Both 401K plans offer you a chance to save money for your retirement.
For the tax year 2020, the IRS has released these updated higher 401k limitations: $19,500 (plus the $6,500 catch-up contribution). We’re happy to discuss with you the benefits of maximizing your 2019 and 2020 401k plan contributions. We can help you determine the best solution both for taxes and your lifestyle that will fit your needs as you move towards retirement.