Limit on 401(k) Savings? It’s About Paying for Tax Cuts

By Patricia Cohen - Oct. 28, 2017

When the benefits adviser Ted Benna first thought up a new type of employee savings plan in 1980, the client he created it for rejected the idea as too risky. After all, no one had previously used the unremarkable section of the tax code called 401(k) to defer paying taxes on money that rank-and-file workers set aside for retirement.

So Mr. Benna decided to try it out at his own workplace, Johnson Companies, a small consulting firm outside Philadelphia.

Without intending to, Mr. Benna set off a revolution. Nearly 40 years later, 401(k) accounts are the most common employer-sponsored retirement plans and a raft on which millions of Americans hope to float through retirement.

Suddenly, though, they are also at the center of a battle around the tax overhaul promised by President Trump and Republican leaders in Congress. A proposal to slash the amount of money workers can put in tax-deferred retirement accounts set off alarms among savers and members of the financial services industry, who contend that limiting the tax break would discourage contributions to 401(k) plans.

Many workers once could depend on defined-benefit pensions, but those plans — expensive for employers — have mostly gone the way of the Walkman. Instead, workers were left with the responsibility of saving for retirement themselves, with individual retirement accounts or 401(k)s. The switch has meant less security.

A retirement crisis already looms. Three out of four Americans worry that they will not have enough money to get through their retirements, according to the National Institute on Retirement Security. About 45 percent have not saved a cent toward it.

Mr. Trump, sensitive to the firestorm that could be provoked by limits on 401(k) contributions, tweeted that there would “be NO change” to this “great and popular middle class tax break” — before conceding it might be a part of legislative horse-trading.

Representative Kevin Brady of Texas, the principal Republican architect of the tax plan in the House, also scrambled to reassure critics that a rewrite would not undermine retirement savings.

“All the focus is on, can we help people save more,” he said.

Yet for all the alarming rhetoric about crushed nest eggs, there are a couple of things to keep in mind.

First, the debate on Capitol Hill is not really about retirement; it’s about lawmakers’ feverish hunt for revenue to finance tax cuts. Second, no matter what happens, it won’t solve the fundamental problem — that many Americans will outlive their savings.

There are several types of subsidized retirement accounts. People who work at larger companies tend to set aside money in a 401(k); they don’t pay taxes until they withdraw funds. By contrast, Americans who open an account known as a Roth get a different kind of break. They pay tax on money before it is deposited, but then get to withdraw it and the subsequent earnings tax-free in the future.

Details of the Republican tax plan have not yet been released, but the talk has been of imposing a cap of $2,400 a year on tax-deferred contributions to 401(k) plans — a sharp reduction from the current ceiling of $18,000 a year for people under 50, and $24,000 for people age 50 and above.

There would still be a tax benefit, but it would probably be under a Roth-style structure.

To some people, enjoying the break when they withdraw money instead of when they deposit it may not make a difference. But for Republicans in Washington desperately seeking a fast boost in revenue, timing is everything.

Their tax bill includes giant reductions in business taxes. Figuring out how to pay for tax cuts is always a grueling task, but it is especially complicated in today’s bitterly partisan atmosphere. Republican lawmakers intend to push through a bill without any Democratic support — but there is a catch. The single-party strategy in this case triggers a rule that requires the policy to have no impact on the budget at the end of 10 years. To make the math work, lawmakers need to come up with the revenue to pay for the cuts sooner rather than later.

That’s where 401(k)’s come in. Rather than allow workers to continue delaying their tax payments, the Republican leadership wants to collect tax revenue on most new contributions upfront so they can use it to pay for those expensive corporate tax cuts. That’s the equivalent of a middle-class tax increase.

“It’s just an enormous budget gimmick,” said William Gale of the nonpartisan Tax Policy Center. “It’s raiding future revenues to pay for current tax cuts. This is not a retirement security story.”

The accounting sleight-of-hand irks Mr. Gale, a former economic adviser to President George H.W. Bush, because, he says, it is financially irresponsible. “It’s just government borrowing by another name,” he said. “You’re not really raising revenue,” just changing when it’s collected.

The question of whether deferring taxes on retirement savings is actually good policy, however, is a separate matter.

Tax-subsidized retirement accounts have long roused fans and critics. Budget cutters point to the trillions of dollars they cost the Treasury Department. Groups concerned about growing inequality complainthat the tax break primarily benefits higher-income Americans who would save for retirement anyway. Those with more modest salaries generally have less access to work-based plans or can’t afford to save. Consumer advocates worry they are too vulnerable to the vagaries of the stock market.

Still, these retirement plans are extremely popular among middle and upper-income voters and many of the politicians who represent them — which is why previous attempts to eliminate them have failed.

Whether a tax-deferred 401(k) or a Roth is a better deal is not clear. Younger workers starting out can reasonably assume they are in a lower tax bracket now and benefit from a Roth, while middle-age workers may assume they will be in a lower bracket after they retire. But mostly there are question marks. Who knows if Congress will raise or lower tax rates 30 years from now, or if someone will shift from a higher tax bracket to a lower one? (It wouldn’t be the first time taxes on retirement income changed — Social Security benefits were shielded from federal income taxes for decades before the law changedin 1983.)

Mr. Gale says he thinks the immediacy of the 401(k) tax break encourages people to save more than they otherwise might. So does Mr. Benna, the 401(k)’s inventor. Although he says the tax deferral alone — without employers matching some of their employees’ contributions — was probably insufficient to persuade lower-wage workers to participate, it has nudged up middle-class savings. “It’s harder to save the same amount after taxes,” he said. “There will be a drop-off in contributions.”

But other experts aren’t so sure.

Andrew Biggs, formerly a principal deputy commissioner of the Social Security Administration, said that for most people, it makes little difference whether they pay taxes on retirement savings now or in the future. Automatic enrollment and the employer matches are much more important than the delayed taxes, said Mr. Biggs, now a retirement specialist at the conservative American Enterprise Institute.

Some studies have confirmed his hunch. One team of researchers looked at a handful of companies that offered a tax-deferred savings plan and then added a Roth option to the menu. They found the total amount of contributions didn’t change much. “The tax deduction was a pretty minor force,” said James Choi, a finance professor at the Yale School of Management and a part of that team.

And depending on future tax law, Mr. Choi said that retirees with Roth accounts could get by with smaller contributions than those with 401(k)’s because they won’t have to pay as much tax on the savings they withdraw.

The possibility that people may save less overall is fueling financial services industry opposition to the tax proposal currently in Congress. Plan administrators — which include major mutual fund companies like Fidelity Investments and Vanguard Group — are paid a share of the assets under their control; if the assets shrink, so do their fees.

What worries Mr. Choi, though, is the Republicans’ idea to cap the amount of tax-deferred contributions at $2,400 a year, while treating the rest like Roth contributions.

Setting the cap there could drag down savings because people tend to interpret such thresholds as recommendations, he said. From that perspective, it would be better to eliminate tax deferrals altogether rather than set such a low ceiling.

Yet whether the 401(k) caps are untouched, slashed or abandoned altogether, the prospect remains that millions of Americans will face retirement with no savings.

Follow Patricia Cohen on Twitter: @PatcohenNYT








This Is What Life Without Retirement Savings Looks Like Many seniors are stuck with lives of never-ending work—a fate that could befall millions in the coming decades.

ALANA SEMUELS FEB 22, 2018

CORONA, Calif.—Roberta Gordon never thought she’d still be alive at age 76. She definitely didn’t think she’d still be working. But every Saturday, she goes down to the local grocery store and hands out samples, earning $50 a day, because she needs the money.

“I’m a working woman again,” she told me, in the common room of the senior apartment complex where she now lives, here in California’s Inland Empire. Gordon has worked dozens of odd jobs throughout her life—as a house cleaner, a home health aide, a telemarketer, a librarian, a fundraiser—but at many times in her life, she didn’t have a steady job that paid into Social Security. She didn’t receive a pension. And she definitely wasn’t making enough to put aside money for retirement.

So now, at 76, she earns $915 a month through Social Security and through Supplemental Security Income, or SSI, a program for low-income seniors. Her rent, which she has had to cover solo since her roommate died in August, is $1,040 a month. She’s been taking on credit-card debt to cover the gap, and to pay for utilities, food, and other essentials. She often goes to a church food bank for supplies.

More and more older people are finding themselves in a similar situation as Baby Boomers reach retirement age without enough savings and as housing costs and medical expenses rise; for instance, a woman in her 80s is paying on average $8,400 in out-of-pocket medical expenses each year, even if she’s covered by Medicare. Many people reaching retirement age don’t have the pensions that lots of workers in previous generations did, and often have not put enough money into their 401(k)s to live off of; the median savings in a 401(k) plan for people between the ages of 55 and 64 is currently just $15,000, according to the National Institute on Retirement Security, a nonprofit. Other workers did not have access to a retirement plan through their employer.

That means that as people reach their mid-60s, they either have to dramatically curtail their spending or keep working to survive. “This will be the first time that we have a lot of people who find themselves downwardly mobile as they grow older,” Diane Oakley, the executive director of the National Institute on Retirement Security, told me. “They’re going to go from being near poor to poor.”

The problem is growing as more Baby Boomers reach retirement age—between 8,000 to 10,000 Americans turn 65 every day, according to Kevin Prindiville, the executive director of Justice in Aging, a nonprofit that addresses senior poverty. Older Americans were the only demographic for whom poverty rates increased in a statistically significant way between 2015 and 2016, according to Census Bureau data. While poverty fell among people 18 and under and people 18 to 64 between 2015 and 2016, it rose to 14.5 percent for people over 65, according to the Census Bureau’s Supplemental Poverty Measure, which is considered a more accurate measure of poverty because it takes into account health-care costs and other big expenses. “In the early decades of our work, we were serving communities that had been poor when they were younger,” Prindiville told me. “Increasingly, we’re seeing folks who are becoming poor for the first time in old age.”

This presents a worrying preview of what could befall millions of workers who will retire in the coming decades. If today’s seniors are struggling with retirement savings, what will become of the people of working age today, many of whom hold unsteady jobs and have patchwork incomes that leave little room for retirement savings? The current wave of senior poverty could just be the beginning. Two-thirds of Americans don’t contribute any money to a 401(k) or other retirement account, according to Census Bureau researchers. And this could have larger implications for the economy. If today’s middle-class households curtail their spending when they retire, the whole economy could suffer.

The retirement-savings system in the United States has three pillars: Social Security, employer-sponsored pensions or retirement-savings plans, and individual savings. But with the rise of less stable jobs and the decline of pensions, a larger share of older Americans are relying only on Social Security, without either of the two other pillars to contribute to their finances. This by definition means they have less money than they did when they were working: Social Security replaces only about 40 percent of an average wage earner’s income when they retire, while financial advisors say that retirees need at least 70 percent of their pre-retirement earnings to live comfortably.

Today’s seniors are so reliant on Social Security in part because companies that once provided pensions began, in the 1970s, to turn the responsibility of retirement saving over to individuals. Rather than “defined benefit” plans, in which people are guaranteed a certain amount of money every year in retirement, they receive “defined contribution” plans, which means the employer sets aside a certain amount of money per year. This switch saved companies money because it asked employees, not employers, to take on the risks associated with long-term investing. This means that the amount people receive is more affected by the ups and downs of the stock market, their individual wages, and interest rates. In 1979, 28 percent of private-sector workers had participated in defined-benefit retirement plans—by 2014, just 2 percent did, according to the Employee Benefit Research Institute, a nonprofit. By contrast, 7 percent of private-sector workers participated in defined-contribution plans in 1979—by 2014, 34 percent did.  

The recession and economic trends in the years since have also worsened the finances of millions of seniors. Some bought homes during the housing boom and then found they owed more on their homes than they were worth, and had to walk away. Others invested in the stock market and saw their investments shrink dramatically. Jackie Matthews, now 76, lost her investments during the recession, and then had to sell her Arizona home in a short sale, netting only $3,000. She now lives near her family in Southern California, renting a room in a friend’s apartment, and budgets her finances carefully, skimping on meat and never buying anything new.

But even people who emerged from the recession relatively unscathed may have a hard time saving, according to a 2017 report from Government Accountability Office. Average wages, when adjusted for inflation, have remained near where they were in the 1970s, which makes it hard for workers to increase their savings. This has had a significant impact on the bottom 80 percent of workers, for whom average wages have remained relatively constant, even as income increased for the top 20 percent of households in the past three decades.

For many seniors, the answer to this lack of savings has meant working longer and longer, as Roberta Gordon is doing. Today, about 12.4 percent of the population aged 65 or older is still in the workforce, up from 3 percent in 2000, according to Oakley. I met a woman named Deborah Belleau who is 67 and works as a manager at a mobile-home park in Palm Springs, California. She worked as a waitress for 30 years, and often relied on government assistance as she raised her two children as a single mother. “You just don’t think about tomorrow” when you’re more worried about getting food on the table, she said. That means that today, though she receives money through Social Security, she can’t afford a cellphone or a TV. Her rent is $600 a month. She works full-time at the mobile-home park, despite aches and pains in her back and feet. Sometimes, when she wakes up, she can’t walk. But, she says, “I can’t quit. There’s no way I can live on $778 a month,” the amount she receives from Social Security.

These troubles can be particularly hard on women. That’s in part because they typically receive lower benefits than men do. In 2014, older women receivedon average $4,500 less annually in Social Security benefits than men did. They received lower wages when they worked, which leads to smaller monthly checks from Social Security. They also are more likely to take time off from work to care for children or aging parents, which translates to less time contributing to Social Security and thus lower monthly benefit amounts.

At least Belleau and others are physically able to work. Some seniors without retirement savings or a safety net have become homeless in recent years as housing costs have risen and they find themselves without the ability to generate income. “I see more homeless seniors than I’ve ever seen before” Rose Mayes, the executive director of the nonprofit Fair Housing Council of Riverside County, just east of Los Angeles, told me. In America in 2016, nearly half of all single homeless adults were aged 50 and older, compared to 11 percent in 1990.

What can be done to help today’s seniors and generations to come? There are two approaches, Prindiville says: help people save for old age and make retirement more affordable. As for the first approach, some states have been trying to establish programs that help people save for retirement through payroll deductions even if their employers don’t offer any retirement-savings accounts, for example. But the Trump administration in May repealed an Obama-era rule from the Department of Labor that would have made it easier for states to help people to set up these plans. And the federal government iswinding down a program, called myRA, that tried to encourage middle- and low-income Americans to save for retirement. “There are no new initiatives or strategies coming out of the federal government at a time when the need is growing,” Prindiville said.

The second approach might mean expanding affordable housing options, creating programs to help seniors cover medical costs, and reforming the Supplemental Security Income program so that poor seniors can receive more benefits.But there does not seem to be much of an appetite for such ideas in Washington right now. In fact, the Trump administration has proposed cutting money from SSI as well as the Social Security Disability Income program.

These initiatives can make the difference between having a home—and some semblance of stability—and not. Roberta Gordon, in Corona, was barely scraping by when I talked to her. A few months later, she was much more stable. Why? She’d gotten off a wait list and been accepted into the housing-voucher program known as Section 8, which reduces the amount of income she has to put towards housing. She’s still working at 76, but she feels a little more secure now that she has more help. She knows, at least, that she’s one of the lucky ones—able, in her older years, to keep food on the table and a roof over her head.


ALANA SEMUELS
 is a staff writer at The Atlantic. She was previously a national correspondent for the Los Angeles Times




Tax Implications of Retirement Accounts – IRA & 401k Distributions & Withdrawals

By Kira Botkin

When your retirement accounts are growing, it’s great to see the numbers climb. But when you retire and start taking money out of your IRA and 401k, the taxes you owe can take a surprisingly big chunk out of your total. Hopefully you’re taking advantage of the tax breaks that come with contributing to most retirement accounts, but are you ready for the taxes and penalties that you’ll deal with when you retire?

The general rule for retirement accounts is that you must either pay taxes on the money before you put it into the account, or when the money comes out. Determining which is better for your situation or what to expect with existing accounts begins with an understanding of the tax implications of various retirement accounts.

Types of Retirement Accounts

Individual Retirement Accounts (IRAs)

You’re allowed to put up to $5,500 (or $6,500 if you’re 50 or older) into your traditional or Roth IRA for 2015 and 2016 if you meet eligibility requirements. Even if you have multiple IRAs, you can’t go over that limit for all accounts combined.

There are two types of IRAs: traditional and Roth. Depending on which type you use, you’ll face different tax implications for contributions and withdrawals.

·      Traditional IRA. You can deduct the total amount you contribute to a traditional IRA, netting you a tax break for the year. Funds within the account will grow on a tax-deferred basis – meaning, you don’t need to pay capital gains tax on the growth. However, when you start making withdrawals in retirement, you’ll pay income tax on the total amount withdrawn. Most withdrawals made prior to turning 59 1/2 will be taxed and penalized a 10% early withdrawal penalty.

·      Roth IRA. A Roth IRA is essentially the opposite of a traditional IRA. You won’t get the immediate tax break when you contribute (you can’t deduct contributions), but when you reach retirement, withdrawals are tax-free. Funds also grow on a tax-free basis while in the account (no capital gains). You can withdraw your contributions to a Roth IRA at any time without paying a tax penalty. However, you generally will have to pay tax and a 10% penalty on earnings withdrawn before you turn 59 1/2.

There are a few exceptions to the early withdrawal penalty for Roth and Traditional IRAs (see below).

401k

Many employers set up a 401k plan for their employees, and make it easy to use payroll deductions for employee contributions. Contributions you make into a 401k reduce your adjusted gross income, lowering your overall tax liability. Employers often also provide a match up to a certain percentage of your salary. The maximum annual employee contribution is $18,000 for 2015 and 2016. Some employees 50 or older may be able to make an additional annual “catch-up” contribution up to $6,000 for 2015 and 2016.

When you eventually make withdrawals, you’ll have to pay taxes on your original contributions and on the account’s earnings. If you withdraw the money early (before you’re 59 1/2 years old), you’ll owe a penalty of 10% of the amount withdrawn, plus taxes.

Some workplaces are now offering Roth 401k plans, which let you determine what portion of your contributions will be made pre-tax or post-tax, and those contributions generally follow the same rules as contributions to a traditional (pre-tax) or Roth (post-tax) IRA.

403b

A 403b account basically has the same rules as a 401k and is a common option for government employees and those working for nonprofit organizations. The maximum annual contribution is also $18,000 for 2015 and 2016. In these accounts, you use payroll deductions to make pre-tax contributions and then pay taxes upon withdrawal. Just like with a 401k, you face a 10% penalty for early withdrawal.

SIMPLE IRA

A Savings Incentive Match Plan for Employees, or SIMPLE IRA, is an option that many small businesses use because they’re less expensive to maintain. These accounts are similar to 401ks in that you contribute money pre-tax and then pay tax when you withdraw. Employees are allowed to contribute up to $12,500 annually for 2015 and 2016, and employers are generally required to match each dollar of an employee’s contribution up to 3% of salary. But if you need to withdraw money early and your account hasn’t been open for more than two years, your penalty is 25% instead of 10% (in addition to income tax on the withdrawal amount).

SEP-IRA

A SEP-IRA is a low-cost, easy-to-manage way to set money aside for retirement if you’re self employed or run a business with a small group of employees. These accounts follow similar rules and withdrawal penalties as a traditional IRA. However, as an employer, you’re able to contribute up to 25% of your income (or your employee’s income) to a SEP – the dollar amount cannot exceed $53,000 for 2015 or 2016.

 

IRA/SEP-IRA/SIMPLE IRA Withdrawal Exemptions

If you have a Roth IRA, you’re in luck – you can withdraw your contributions to a Roth IRA at any time without paying taxes or penalty fees. However, if you want to withdraw earnings from a Roth (you’ve already withdrawn the total contributions amount) or make withdrawals from a traditional type IRA, you’ll likely pay a penalty unless you also meet one of the conditions below.

·      IRA Rollover. You won’t be liable for taxes or penalties in completing a direct rollover to another IRA – transferring some or all of the money from one IRA account to another without taking possession of the money. As of January 1, 2015, however, the IRS only allows taxpayers to make one rollover per year.

·      Payout and Deposit. A lump sum payout from an IRA that you deposit into another IRA within 60 days won’t result in penalties or taxes.

·      Disability.  Withdrawals made if you’re permanently or totally disabled won’t result in penalties.

·      Health Premiums. Paying health insurance premiums with withdrawals during unemployment won’t result in penalties.

·      Specified College Expenses. Paying for college expenses for yourself or a dependent (only qualified expenses are eligible) with withdrawals may not result in penalties.

·      New Home Purchase. You won’t be penalized if you use up to $10,000 to purchase a home, if you haven’t owned a home over the past two years. There is a $10,000 lifetime maximum for this exception.

·      Specified Medical Expenses. Using a distribution to cover medical expenses that exceed 10% of your adjusted gross income (7.5% if you or your spouse were born before January 2, 1951) won’t trigger the penalty.

·      IRS Levies. Funds withdrawn to pay levies by the IRS to pay off your tax debts won’t be penalized.

 

401k/403b Withdrawal Exemptions

If you want to withdraw money from a 401k or 403b without penalty, determine whether you meet any of the following exemptions:

·      IRA Rollover or Deposit. A direct rollover to an IRA, or a lump sum payout that you deposit into an IRA within 60 days won’t be penalized or taxed.

·      Disability. Withdrawals made if you’re disabled won’t be penalized.

·      Death. Amounts withdrawn by your beneficiary or estate after your death won’t be assessed a penalty.

·      Retirement. Retiring at age 55 or older and withdrawing funds won’t trigger the penalty.

·      Specified Medical Expenses. Using withdrawals to pay for medical expenses that exceed 10% (7.5% if you or your spouse was born before January 2, 1951) of your adjusted gross income won’t result in a penalty.

·      Divorce. Withdrawals made following the rules of a divorce decree or separation agreement (also known as a qualified domestic relations court order) won’t be penalized.

 

Required Minimum Distributions

While drawing from your account too soon can result in penalties, the IRS also has rules that prevent you from taking distributions too late as well. Required minimum distributions (RMDs) are withdrawals you must make the year you turn 70 1/2. One exception is a Roth IRA, which doesn’t have RMDs and does not require withdrawals until after the death of the owner.

Additionally, if you are still working at 70 1/2, unless you own shares in your company, you can delay RMDs from employer-sponsored accounts such as a 401k until the year in which you retire. But you can’t put off taking RMDs from an IRA. In fact, the companies that manage retirement accounts send annual reports to the IRS; if the IRS sees that you’re not taking RMDs, you can face a tax of up to 50% on the amount you should have withdrawn.

The amount of your RMD will depend on your age, marital status, and the total value of all of your retirement accounts. The IRS publishes tables annually that list the required minimums. If you have more than one retirement account, you need to determine how much you have to take from each account. You may not turn around and deposit the withdrawals into another retirement account, but you can move the funds to an interest-bearing savings account like Ally Bank.

In the event that you inherit an IRA, 401k, or other retirement account from someone who was not your spouse, you can choose to either withdraw the entire amount within five years of the original owner’s death, or you can take required minimum distributions over your entire lifetime. Taking the entire amount means a huge tax hit, so many people choose to take RMDs to spread out the tax burden. (When a spouse inherits, he or she can often take ownership of the account and follows different rules.)

Final Word

It’s important to understand the tax implications of your accounts so that you know how much money you’ll actually have available to you when you need it. Many people focus on the account amount instead of the amount they’ll see after taxes. But the last thing you want is to realize just before retirement that taxes will set you back such that you’ll have to delay it.

What Is An Individual 401k Plan? 401k Limits, Rules, and Benefits Explained

By Mark Riddix 

There are so many retirement plans to choose from when planning for retirement. We have previously covered the Roth 401k plan, the traditional IRA, the Roth IRA fund, and all of the advantages and disadvantages of each of these options. The plan that I want to cover today is probably the one you’ve heard about the most and the one that gets the most media attention: the traditional 401k plan.

Let’s take a look at some of the key features of a traditional 401k plan:

 

Tax Deduction

401k plans are the most popular employer-sponsored defined contribution plans available today. Every contribution that an employee makes to the plan entitles an employee to a tax deduction. 401k contributions that are taken directly from your paycheck are free from income taxes. Taxes are not paid until you take a withdrawal from your account.

As an example, let’s say you contributed $10,000 to your 401k plan during the year. Based on the current rules, your taxable income would be lowered by $10,000 for the current year. You would not have to pay taxes on the funds until you take a withdrawal from your account. This allows you to contribute more to your plan and lower your taxes.

401k plans require that plan participants take a withdrawal by the age of 70 ½. Plan participants must begin withdrawing money by April 1st of the year after you turn 70½. This amount is known as the required minimum distribution (RMD). An account owner who fails to take out the required minimum distribution will find their account subject to an IRS penalty. This requirement is one way for the government to guarantee that it will receive taxes on your money at some point.

The 401k tax feature is the exact opposite of the tax features of the Roth IRA and the Roth 401k plan. With these accounts, while the contributions to the fund are not tax deductible, any withdrawals (including any capital gains), can be taken out of the account tax-free upon retirement.

Employer & Employee Matching Program

The biggest advantage of a 401k is the employer match. An employer match is free money that your employer is contributing to your account. Most employers will match employee contributions dollar for dollar up to a certain percentage.

Again, as discussed in the prior section, the tax deferral benefit allows employees to postpone taxes until much later in the future. Plan participants should aim to schedule withdrawals so that they are paying lower taxes in the future than they would today.

Maximum Contribution

The current maximum 401k contribution limit is $16,500 for adults that are under the age of 50. Adults that are 50 and over can contribute an additional $5,500 due to catch-up provisions.

Highly compensated workers may not be eligible to fully contribute to their company’s 401k. An individual is considered a highly compensated employee if he or she currently makes over $110,000 per year or owns more than a 5% interest in the employer’s business.

How To Participate In A 401k

You can only participate in a 401k plan if your employer offers the plan. These plans are a hit with employees because of the tax savings and the matching contributions.

401k plans are a great way to put your retirement saving on cruise control. Having your contributions directly deducted from your paycheck takes the burden off of your shoulders. You can also structure your 401k to split your contributions between money market funds, stock funds, bond funds, and company stock. Check with your employer to see what funds your 401k offers.

Final Word

The traditional 401k plan is as popular and widespread as it is because it has some truly unique benefits and can be crucial to someone’s retirement.  However, don’t forget that there are other options out there that you can use in place of or in conjunction with your 401k plan: Roth 401k, Roth IRA, Traditional IRA. Each plan has something to offer you. Depending on your personal financial situation, you need to choose the best plan for you.

The People Who Evangelized for the 401(k) Now Think It’s Made Retirement Much Tougher

We’re not even a week into 2017, and we already have another reason to feel gloomy about our futures. The Wall Street Journal’s Timothy Martin tracked down several early proponents of the 401(k) and asked them what they think of their innovation, which has supplanted the traditional pension at most companies. Answer: not much!

Herbert Whitehouse, a former Johnson & Johnson human resources executive who pushed the then-new savings vehicle in the early 1980s, now says even he can’t retire until his mid-70s if he wishes to maintain his standard of living, because, Martin writes, his 401(k) “took a hit” in 2008. He’s 65. And Ted Benna, the man most frequently credited for the 401(k) as we know it, says he doesn’t believe “any system currently in existence” can help most Americans finance their financial needs in retirement. Oof.

What went wrong? The 401(k) began as a technical adjustment to the tax code, one meant to mostly impact high-earning executives using profit-sharing plans. People like Benna, a benefits consultant, convinced the Reagan administration that the language of the statute allowed for all employees to put aside a portion of their salaries on a tax-deferred basis. It was supposed to supplement corporate pensions. Instead, in something almost no one foresaw, the 401(k) replaced them.

In 2017, we know that this historic accident isn’t working out for many people. The Center for Retirement Research currently estimates that about 52 percent of households are “at risk of not having enough to maintain their living standards in retirement” with “the outlook for retiring Baby Boomers and Generation Xers far less sanguine than for current retirees.” The Economic Policy Institute says just under half of households headed by someone between the ages of 32 and 61 have nothing saved for retirement.