401k & IRA Snapshot
Saving for retirement is a necessity for everyone and the earlier you start the better. 401(k) and IRAs are savings vehicles that also provide tax savings, a win-win. Let’s dive into more detail.
401k
The 401k is offered by employers allowing you to contribute, pre-tax, per paycheck. Pre-tax means you are not subject to federal and state tax. The contribution is then invested into a mutual fund or exchange traded fund (ETF) of your choosing. in 2024, the maximum contribution is $23,000. If you are over 50 you may contribute an additional $7,500. As mentioned above you do not have to pay federal or state taxes on this contribution. Putting this in perspective, let’s say you are effective tax rate is 14% for federal and 3% for state. If you contributed $10,000 in 2024 you will have saved $1,700 ($10,000 x 17%) in taxes. Prior to investing your contributions you are $1,700 ahead.
Now the second advantage to a 401(k) plan is the employer typically matches your contribution up to a certain percentage of your income. A typical match is 50% of your contribution up to a maximum of 4% of your salary. In the above scenario the contribution was $10,000, your employer would match 50% or $5,000! This match amount is never taxed upon receipt. Your tax savings on the match is and additional $850 ($5,000 x 17%). The match is then invested in the fund of your choice.
To start contributing to your 401(k) plan set your contribution percent to receive the maximum Employer match amount. This is a good entry point to make sure it fits in your cashflow. Having the additional understanding that you do not have to pay taxes on this money you will realize that you may not see a change in your cashflow due to the decrease in tax. Said another way, instead of paying taxes on your income you are saving to the 401(k) plan.
As your income increases make sure you increase your contribution percentage with the goal of reaching the annual maximum contribution.
IRA
An Individual Retirement Account (IRA) is a savings program that is offered if your employer does not offer a 401(k) plan or if you do not participate in a retirement plan. The only requirement is you must have earned income as found on a W-2 or 1099 or K-1.
The contribution amount for 2024 is $7,000 and is deductible on your tax return. You do not have to make the contribution until the tax filing deadline, or April 15th to qualify for a prior year tax deduction.
You are still eligible to contribute to an IRA if you do participate in a 401(k) plan however there are income limitations to determine if it is deductible on your tax return. Visit IRS.gov for income limit tables. Non-deductible IRA contributions are allowed. Many people like this opportunity as the funds are invested, they grow tax free. In this situation it is important to track the year and amount that was non-deductible to avoid paying tax on withdrawals in the future. Your initial contribution will never be taxed.
The 2024 maximum contribution amount is $7,000, unless you are over 50 where you can contribute another $1,000. This will reduce your taxable income if you meet the rules. If you have an effective tax rate of 15%, your tax savings would be $1,050. In effect the government is incentivizing you to save.
Another retirement savings incentive is if your spouse does not work, they too can open an IRA and contribute the maximum amount based on the spouses earnings.
For more details Call Gina at 747-599-0700 to see which plan applied to you.