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Why You Should Maximize your 401k Contributions

stacks of coins next to a tree in a sack

401(k) retirement contributions through your employer plan is a great way to reduce taxes and build up tax deferred or tax-free retirement assets.

Are you contributing the maximum amount allowed by law?  Are you taking full advantage of your employer match?  Increasing your contributions now allows your nest egg to grow faster due to compounding in a tax deferred account (and it grows tax-free in a ROTH account).

As an employee with a 401(k) account, you can elect to defer a portion of your pay into the plan.  For 2020 the contribution limit is $19,500.  Employees age 50 or older by year end are permitted to make catch up contributions of $6,500 for a total limit of $26,000 in 2020 and 2021.

Benefits of a Traditional 401(k):

  • Contributions reduce your current taxable income, which can lower your current taxes and potentially reduce your exposure to the 3.8% net investment income tax or other income sensitive deductions or taxes
  • Assets grow tax deferred until you withdraw them
  • Employers can make matching contributions that are not taxable to you until you withdraw the funds.

Review your contributions and see if you can increase them to the maximum level.  Keep in mind that there is no income tax on these pre-tax contributions.

Benefits of a ROTH 401(k)

Employers may include this option in your plan.  You can designate some or all of your contributions as ROTH contributions.  These contributions will not decrease your taxable income but qualified distributions will be tax-free.

If you are a high income earner you might not be able to make ROTH IRA contributions.  The ability to make ROTH IRA contributions will be reduced if your adjusted gross income exceeds:

  • $198,000 for married filing joint (2020 level $196,000)
  • $125,000 for single taxpayers (2020 level $124,000)

Please contact your tax advisor at Wegner CPAs to review your contributions and review what changes to your contributions would mean to your overall tax situation.

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