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When it comes to retirement planning, many people are confused about the different types of accounts available, especially when it comes to the 401k.
Most investors might not even know the difference between a 401k and an IRA, let alone how much they can contribute to one.
But not you—you’re here, and you’ve taken the first step by following A.B. Ridgeway, a Certified Private Wealth Advisor®️ professional with over a decade of experience.
In this blog post, we’ll dive deep into the 401k plan, unraveling its complexities, and giving you a clear understanding of how much you can contribute, the benefits, and why it's an essential part of your financial future.
This blog draws from our latest episode of "Financial Advisors Say The Darndest Things Podcast" where we discuss the intricacies of retirement accounts and why understanding them is crucial to your financial health.
What Is a 401k and Why Is It Important?
A 401k is a retirement savings plan sponsored by an employer. It allows employees to save and invest a portion of their paycheck before taxes are deducted.
One of the most significant benefits of a 401k is that the contributions are made pre-tax, which reduces your taxable income for the year.
This means more money in your pocket and a lower tax bill come April.
Additionally, many employers offer a matching contribution, which is essentially free money that adds to your retirement savings.
Understanding the ins and outs of a 401k is crucial because it can be one of the most powerful tools for building a secure retirement.
However, like any financial instrument, it comes with rules, limits, and strategies that you need to know to make the most out of it.
401k Contribution Limits for 2024: A Breakdown
One of the most common questions about 401ks is, "How much can I contribute?"
For 2024, the IRS has set the following contribution limits:
- **For individuals under 50:** You can contribute up to $23,000.
- **For those 50 and older:** You can contribute up to $30,500.
These limits are subject to annual adjustments based on cost-of-living increases, which makes it essential to stay informed each year. The contribution limits are set by the IRS to encourage saving while ensuring that retirement benefits are distributed fairly among employees.
It’s important to note that these contribution limits apply only to the amount you, as the employee, can contribute. The total contribution, including both employee and employer contributions, has a different limit, which we’ll discuss shortly.
Understanding the Two Types of Contributions: Employee vs. Employer
There are two primary types of contributions in a 401k plan:
1. Employee Contributions: This is the amount you decide to defer from your paycheck into your 401k. These contributions are made on a pre-tax basis, which means they reduce your taxable income for the year.
For example, if you earn $60,000 per year and contribute $10,000 to your 401k, your taxable income would be reduced to $50,000. This not only helps lower your current tax bill but also allows your investments to grow tax-deferred until retirement.
A common misconception is that 401k contributions are double-taxed.
This is not true.
Contributions to a 401k are made before taxes, and you only pay taxes when you withdraw the money in retirement.
These withdrawals are taxed as ordinary income, not at the potentially lower capital gains tax rate. This makes it essential to plan your withdrawals carefully to avoid higher tax rates in retirement.
2. Employer Contributions: Some employers offer to match a portion of your contributions as part of your benefits package. This match is typically up to a certain percentage of your salary.
For example, if your employer offers a 5% match and you earn $60,000, they would contribute up to $3,000 to your 401k if you also contribute at least $3,000.
Employer contributions are not mandatory, and the percentage they match can vary widely. It’s crucial to understand your company’s 401k plan and take full advantage of any match they offer if it works for you.
This match is often referred to as "free money" because it's an addition to your salary that can significantly boost your retirement savings.
Maximizing Your 401k Contributions: Going Beyond the Basics
Beyond the basic employee contribution limits, there are additional rules and strategies you should be aware of:
- Maximum Total 401k Contributions:
The combined limit for employee and employer contributions in 2024 is the lesser of $69,000 for those under 50 ($76,500 for those 50 and up) or 100% of your compensation.
This means that if your employer offers a generous match, you could potentially contribute more than the individual limit of $23,000/$30,500, but the total combined contributions cannot exceed these limits.
- 401k Catch-Up Contributions:
If you’re 50 or older, you can make additional "catch-up" contributions to your 401k.
In 2024, this catch-up contribution limit is $7,500, bringing your total possible contribution to $30,500. This is designed to help those closer to retirement make up for any lost time and boost their retirement savings as they near the end of their careers.
Starting in January 2025, individuals aged 60-63 will be able to make even larger catch-up contributions of $10,000, with this limit indexed for inflation.
This provision is part of a broader effort to help those who may not have saved enough during their early working years.
-Why 401ks Are a Key Component of Retirement Planning
A 401k is more than just a retirement account; it’s a tool for building long-term wealth. The pre-tax contributions, combined with potential employer matching and tax-deferred growth, make it an incredibly effective way to save for retirement.
One of the biggest advantages of a 401k is the ability to defer taxes on your contributions until retirement. This allows your investments to grow without the drag of annual taxes, which can significantly increase your retirement savings over time.
Additionally, many 401k plans allow you to borrow against your balance without triggering a taxable event. This can be a lifesaver in case of emergencies, providing you with a source of funds without the penalties and taxes associated with early withdrawals.
However, it’s important to be aware that 401ks often have limited investment options. Most plans offer a selection of mutual funds, ranging from conservative to aggressive, but you typically won’t have the ability to pick individual stocks or other assets.
Despite this, the tax advantages and potential employer match make 401ks a cornerstone of any retirement plan.
Common Misconceptions About 401ks
There are several misconceptions about 401ks that can lead to costly mistakes:
- Tax Treatment:
As mentioned earlier, some people believe that 401k withdrawals receive the same tax treatment as long-term capital gains, which are typically taxed at a lower rate.
This is not true.
Withdrawals from a 401k are taxed as ordinary income, regardless of how long the money has been invested.
This makes it crucial to plan your retirement income and withdrawals to minimize your tax liability.
- Investment Choices:
Another misconception is that you have complete control over your investment options within a 401k. In reality, your choices are usually limited to a pre-selected range of funds.
While this can simplify the decision-making process, it can also limit your ability to tailor your investments to your specific goals and risk tolerance.
- Employer Matching:
Some employees assume that their employer will automatically contribute the maximum match to their 401k. However, most employers only match contributions up to a certain percentage of your salary, and you need to contribute enough to receive the full match. Failing to do so is like leaving money on the table.
Also, it may not be necessary to overfund that account beyond the match. There are other retirement options you may want to leverage such as contributing to an Individual Retirement Account (IRA).
The Importance of a Comprehensive 401k Retirement Plan
While a 401k is a powerful tool, it should be just one part of a comprehensive retirement plan. Other accounts, such as IRAs and Roth IRAs, offer additional benefits and flexibility that can complement your 401k.
For example, a Roth IRA allows you to contribute after-tax dollars and withdraw them tax-free in retirement, providing a hedge against future tax increases.
Understanding the different types of retirement accounts and how they work together is crucial for maximizing your retirement savings and minimizing taxes.
It’s also important to regularly review your retirement plan and make adjustments as needed, especially as you get closer to retirement.
Final Thoughts: Making the Most of Your 401k
Understanding how much you can contribute to a 401k and the benefits of doing so is just the first step in building a secure financial future. The key is to take full advantage of the opportunities available to you, such as employer matching, tax-deferred growth, and catch-up contributions if you’re 50 or older.
If you’re unsure about how to optimize your 401k or need help navigating your retirement options, I’m here to help. Visit my website at https://www.abrwealthmanagement.com to schedule a consultation.
I can help you review your current retirement plan, identify any gaps, and develop a strategy that aligns with your goals.
For those new to investing or if the terminology around retirement accounts sounds like a foreign language, don’t worry—I’ve got something just for you.
Download our free e-book, "The Four Pillars to a Christian Financial Plan."
This e-book covers everything from debt management to investing and wealth transfer, offering a comprehensive guide to building a financial foundation that honors your faith.
Planning for retirement doesn’t have to be overwhelming, and understanding your 401k is a crucial part of that process. By knowing how much you can contribute and taking advantage of employer matching, you can significantly boost your retirement savings and set yourself up for a secure and blessed future.
Make sure to subscribe to our mailing list for more faith-based financial advice, and don’t forget to download our free e-book to get started on your journey.
Peace and Blessings,
A.B. Ridgeway, CPWA®️, MBA
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As Christians, we were taught to be good stewards over our tithing and giving to the less fortunate. But when it came to our personal finances and investing we were left clueless on what the Bible says. What does the Bible say about managing debt, leaving a legacy, investing, and planning for your retirement? Mr. Christian Finance answers these and many other questions because we want to teach you how to become rich and righteous!
Meet A.B. Ridgeway:
A.B. Ridgeway, MBA, CPWA®️ (info@abrwealthmanagement.com) is the owner and Christian Financial Advisor with A.B. Ridgeway Wealth Management. With a decade in the finance industry, his goal is to give believers clarity around the most confusing topic in the Bible, money, and tithing. A.B. Ridgeway helps tithing Christians become cheerful givers but unlocking their money-making potential, so they can prosper and be the great stewards of the wealth God has entrusted them with.
*Disclaimer: This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned. This is strictly for information purposes. We recommend you speak with a professional financial advisor.
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