A 401(k) plan provides tax breaks, employer contributions, an opportunity for automatic saving and the potential for investment growth.
But you also need to avoid 401(k) fees and penalties in order to make the most of your account. Here’s how to maximize the value of your 401(k) account in 2019:
- Qualify for tax breaks
- Make catch-up contributions
- Reset your automatic contributions
- Get a 401(k) match
- Consider a Roth 401(k)
- Select low cost funds
- Avoid penalties
- Sign up for direct deposit
- Increase your withholding
- Don’t stick with the default savings rate
Qualify for tax breaks
You can defer paying income tax on up to $19,000 that you save in a 401(k) plan in 2019, $500 more than in 2018. A worker in the 24 percent tax bracket who saves this amount could reduce his tax bill by $4,560. Income tax won’t be due on this money until it is withdrawn from the account. Workers who earn less than $32,000 in 2019 ($64,000 for couples) might additionally qualify for the saver’s credit, which is worth between 10 and 50 percent of 401(k) contributions up to $2,000 for individuals and $4,000 for couples.
Make catch-up contributions
Employees age 50 and older are eligible to save an additional $6,000 in a 401(k) plan in 2019, for a total 401(k) contribution of $25,000. A 55-year-old employee in the 24 percent tax bracket who maxes out his 401(k) plan could reduce his current tax bill by $6,000.
Reset your automatic contributions
The 401(k) contribution limit increased by $500 in 2019, which means workers are eligible to contribute about $41 more per month. Those who want to max out their 401(k) in 2019 need to save approximately $1,583 per month, or $791 per twice monthly paycheck. Workers age 50 and older can defer paying income tax on as much as $2,083 per month.
Get a 401(k) match
If you can’t max out your 401(k), aim to save at least enough to get a 401(k) match. A 401(k) match of 50 cents for each dollar you save in the 401(k) plan up to 6 percent of pay is a 50 percent return on your investment. A dollar-for-dollar 401(k) match doubles your money. However, you need to be vested in the 401(k) plan in order keep your employer’s contributions to the plan, which might require several years on the job.
Consider a Roth 401(k)
Traditional 401(k) plans allow you to defer paying income tax on your retirement savings, but some employers additionally provide an after-tax Roth 401(k) option. You don’t have to pay income tax on the investment gains in the Roth 401(k) account, and withdrawals in retirement are typically tax-free. A 401(k) match might be provided for Roth 401(k) contributions, but it will be deposited in a traditional 401(k), so you will have pre and post-tax accounts to draw from in retirement.
Select low cost funds
401(k) fees are deducted from your returns regardless of how your investments perform. Your plan sponsor is required to send you a 401(k) fee disclosure statement that lists how much each fund in your 401(k) plan costs to own. Find out if your 401(k) plan provides a lower cost fund that meets your investment needs.
There are penalties if you take money out of your 401(k) account too soon or too late. You will be charged a 10 percent early withdrawal penalty if you initiate a distribution before age 55. There’s also a 50 percent penalty if you fail to take a required minimum distribution, and pay the resulting income tax bill, after age 70 1/2.
Sign up for direct deposit
Contributions to your 401(k) plan are typically withheld from your paycheck before you ever get a chance to spend them. This is the fastest way to get money into your account and reduces the temptation to skip a deposit.
Increase your withholding
As you get raises and bonuses, consider redirecting a part of your pay increase to your 401(k) plan. Some 401(k) plans have an automatic escalation feature that will increase your savings rate over time without any further action.
Don’t stick with the default savings rate
Many employees are automatically enrolled in their workplace 401(k) plan. When this happens, the default savings rate is typically 3 percent of pay. This low savings rate isn’t likely to produce a big enough nest egg to retire comfortably and might not allow you to get the entire 401(k) match. Take care to select a savings rate that will provide you with the retirement income you need.
Source: U.S. & World Report News
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