The Hidden Tax Break in Your 401k

Planning for retirement can seem a bit complicated given the numerous elements involved – pensions, IRAs, and 401(k). Many taxpayers feel unsure about which retirement plan is best suited for them. In this article, we will discuss the tax benefits your 401(k) plan can bring you. This information may help you decide the best route for your retirement.

What is a 401(k)?

A 401(k) is an employer-sponsored retirement plan. Money from your paycheck is contributed towards your account with pre-tax money. This means that you won’t be taxed on the income put into your account the year you are paid for it.

How Much Can I Contribute?

In 2015, employees were allowed to contribute up to $18,000 of pre-tax income to their 401(k). This amount is around $12,000 more than those who own both a traditional or Roth IRA account. Employees can put in double the amount of money over those with IRA accounts because taxes aren’t paid on the money until the taxpayer is 59 ½ years old.

Early Distribution

Withdrawing before the required age will leave a 10% penalty on your account, taking a good chunk of money out of your 401k. If the taxpayer retires or is fired from their job after the age of 55 they are allowed to dip into their 401(k) fund without the penalty.

Closing Thoughts

When the contributions of your 401(k) are paid through pre-tax capital, your employer will not include these figures in your taxable revenue for the year. Your 401(k) not only reduces your income tax but also increases your take-home pay since your chargeable income is less than your actual salary.

Image credit: Tax Credits