5 tips for maximizing 401(k) tax benefits
By Paula Aven Gladych
It is tax time again and many Americans are struggling to wade through the piles of W-2s and 1099s to beat the April deadline. Charles Schwab Retirement Plan Services believes now is a good time for employees to know what they can do to maximize the tax benefits they receive from participating in their employer-sponsored 401(k) plan. It recommends these top five tips (presented here from 5 to 1) for better utilizing workplace retirement plans: 5. Avoid 401(k) loans, even when money is tight. Borrowing from your 401(k) should be an absolute last resort. Loans from a 401(k) plan must be repaid with after-tax dollars, negating many of the tax benefits of a 401(k). And, if you leave your job and are unable to repay the loan in-full, the outstanding balance is treated like a withdrawal, triggering a tax bill and potentially a 10 percent penalty on top of the tax. 4. Don’t burden yourself with withdrawals. Any withdrawal from a 401(k) plan can carry significant tax consequences. If you withdraw money from your employer-sponsored retirement plan before the age of 59½, you'll likely face a 10 percent federal penalty. What's more, the government will take 20 percent of your withdrawal as an advance on your tax bill. Plus, some plans may bar employees who have taken a withdrawal from contributing for the next six months, causing another blow to your savings that can impact your long-term financial goals. 3. Get to know the Roth. A Roth 401(k) can offer a different kind of strategic tax planning opportunity. In a traditional 401(k) plan, contributions are made on a pre-tax basis, and taxes are paid when you take distributions from the plan. In a Roth 401(k), contributions are made on an after-tax basis, and distributions of any investment earnings are tax-free after you meet certain requirements. 2. Get credit where credit’s due. Depending on your income and filing status, contributions to a qualified 401(k) plan may further lower your tax bill through the Saver's Credit (formerly known as the Retirement Savings Contributions Credit). The credit was established in 2002 and directly reduces your taxable income by a percentage of the amount you put into your 401(k) plan. According to the IRS, those who meet eligibility requirements can take a credit of up to $2,000 if filing jointly. 1. Bump up or max out your contributions. Traditional 401(k) plans are funded with pre-tax dollars, which lowers a person’s taxable income. Making a significant contribution could put you into a lower tax bracket entirely, allowing you to keep even more of your paycheck. Studies have shown that a mere 10 percent of participants max out their contributions, so there is definitely room for most Americans to get more aggressive with their savings rate.
Originally published on BenefitsPro.com