How to use retirement for double the savings: 401(k) tax benefits

October 19, 2015 : H&R Block

Part two of a three-part series on saving money and maximizing benefits during open enrollment

Part one: FSAs and HSAs | Part three: marketplace open enrollment

Employees in open enrollment season at their workplaces have a chance to ensure they get the most out of their benefits – and their paychecks. For example, enrolling in a health savings account can reduce their taxes. And retirement savings can go beyond planning for the future, with 401(k) tax benefits to make saving more affordable now.

401(k) tax benefits make saving more affordable

Contributions to a 401(k) are not subject to income tax. This reduces an employee’s taxable income and potentially the tax bill. This gives the taxpayer more take-home pay compared to other savings accounts that do not offer pretax benefits.

Taxpayers can contribute as much as $18,000 in 2015. Those 50 and older can make “catch-up” contributions of an additional $6,500 in 2015. An employee with a marginal tax rate of 25 percent could save $4,500 to $6,125 in taxes by maxing out their 401(k) contributions.

401(k) tax benefits make saving go further

Many employers match their employees’ 401(k) contributions up to a certain amount or percentage. Not only does the employer match get the same pretax benefit, but the employer’s contributions do not count toward the contribution limits set for the employee. An employer 401(k) match is tax free money to the taxpayer, who does not have to pay tax on the contribution as income and can continue to receive tax benefits for their own contributions.

401(k) tax benefits have some limits

The money in a 401(k) isn’t tax free forever. When a taxpayer turns 59½, they may begin to take distributions from their 401(k) (if plan rules allow for distributions) without a penalty. However, they will pay income taxes on the distributions. If they take distributions before their 59½ birthday, they will pay income taxes and a 10 percent penalty for the early withdrawal unless an exception applies.

Taxpayers generally must begin taking required minimum distributions (RMDs) for the year in which they turn 70½. If they do not take RMDs after the required beginning date, they will have to pay a 50 percent penalty on the minimum they did not withdraw.

Additional qualification requirements and contribution limits could influence specific situations for individual taxpayers. Anyone wishing to maximize their 401(k) tax benefits this open enrollment season should talk to a trusted tax professional about their situation.

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