For 2015, you can contribute up to $18,000 to your 401(k). If you'll reach age 50 by December 31, you can also make "catch-up" contributions (up to $6,000 for 2015). So if you didn't contribute much when you were younger, this may allow you to partially make up for lost time. Because of tax-deferred compounding, boosting contributions sooner rather than later can have a significant impact on the size of your nest egg at retirement.
Contributing to a traditional employer-sponsored defined contribution plan, such as a 401(k), 403(b) or 457 plan, offers many benefits:
|▪||Contributions are pretax, reducing your modified adjusted gross income (MAGI), which can also help you reduce or avoid exposure to the 3.8% net investment income tax and increase your itemized deductions, thus lowering your income tax.|
|▪||Plan assets can grow tax-deferred — meaning you pay no income tax until you take distributions.|
|▪||Your employer may match some or all of your contributions pretax.|
These plans can also provide a permanent state tax benefit. You can defer state income tax now on the contribution to the plan and take distributions later while residing in a state without an income tax, and therefore effectively escape state taxation on the income.
The downside of these plans is that all of the contributions and income, including capital appreciation will be taxed as ordinary income when you take distributions from the plan. Also, you will incur a 10% penalty, in addition to any income tax, on early withdrawal from the plan before age 59½ (some exceptions apply).
Questions about how much to contribute? Please contact us. We'd be pleased to discuss the tax and retirement-saving considerations with you.
Hal Zemel, a Tax Principal at Berdon LLP, has more than 20 years in public accounting and advises businesses in the real estate, service, and manufacturing sectors.