As part of your financial health, maximize your tax-advantaged retirement accounts. These accounts are the first place to put money. You should not be playing in the stock market on E-trade. Not be buying a fancy new car. Instead optimize your tax-advantaged accounts.
Some would argue that these accounts should be funded before even paying down high interest debt (think credit cards, but for me anything > 4% is high interest.). If your employer provides a match to these account then I agree (Free money anyone!). Fund these accounts to the degree needed to get the full match. After that, tackle your high interest loans.
Tax advantaged accounts
So what are the different types of tax advantaged accounts? There are a few and here I will briefly cover 401(k), 403(b), 457, and government TSP plans,
The 401(k)is the basic retirement plan for most individuals now. Starting in the 1980’s, it was not meant to be the primary retirement source for individuals. But as the years passed and companies saw that they could save millions and billions by forgoing pensions, it has now become most Americans main retirement plan. Even the father of the 401(k) thinks it has gotten out of hand. Still it is what most of us have, so we may as well make the best out of it.
So what is a 401(k)plan
In it’s basic form it is a tax-qualified, defined-contribution pension. You as the employee can contribute any amount of your paycheck up to $18,000 (in 2017). Your employer may or may not match a portion of that money. This money then sits in an account, invested in the market, growing until you are ready to retire. If the market loses value, your 401(k)loses value. If the market gains, your 401(k)1k gains.
Traditional 401(k) plans are tax deferred, meaning the money is taken out of your paycheck before taxes are applied. That money then grows tax free until you are ready to withdraw it. Once in retirement, as you take the money out, you are taxed on any gains.
Who should go with a traditional 401(k)
Any high earners who expect to make less as they get older. Traditional 401(k)s are great for the peak earning years because it lowers the overall tax burden by up to $18,000. Personally this is what I do as explained here.
Roth 401(k) plans are taxed when the money is put into the account. So if you put $18,000 into an account you will be taxed on that $18,000 at your current income level. The money then grows tax free and when you are ready to withdraw it, you pay NO taxes. This is great as the money in your account is actually all yours (no more is due to the greedy tax man).
Who should go with a Roth 401(k)
Individuals who have the money to pay the taxes should consider this plan.
Low income earners who will be taxed at a lower rate. For instance, I am investing in a traditional 401(k)now, but if and when I go to part time then my income will be less and I will likely rollover my money from a traditional account to a Roth. I will have a big tax bill at that time but it will be lower than if I did a rollover now.
The current maximum limit for contributing to a 401(k)is $18,000. If you can afford to I would recommend contributing this amount. At a minimum you should contribute enough to get your employer’s full match (think free money!). This may be as low as $0 (find a new employer) or as even up to $18,000 (rare but I have heard of a complete match before). If your employer matches 4% of your salary, then contribute at least 4%!
If you are going to be 50 years old at the end of the tax year you can contribute an additional $6,000 catch up into your 401k
If you withdraw the money before 59.5 years old, the IRS will place a 10% tax except under certain conditions. These may include medical expenses, purchase of a home, tuition payment, and other hardships. Check with the IRS if you are going to withdraw money before 59.5 years old.
At 70.5 years old or the April after retirement, you must start withdrawing funds. This applies to both traditional and roth 401(k)s (not Roth IRA’s though).
Highly compensated employees
The IRS puts a limit on highly compensated employees. Based on the deferral of non-highly compensated employees. Highly compensated employees earn either >$100,000 a year or are the top 20% of earners for the company. The average deferral percentage of this group cannot be above 2% more than all non-highly compensated employees.
This affected me at my last job. Based on my salary I could not contribute all $18,000 into my 401(k)and had to use a 403b to hit my $18,000 limit of tax deferred investment. .
A 403(b) is another tax advantaged retirement plan available to public service employees and some non-for-profit organizations. It is similar to a 401(k). Money is put into this account before income taxes are taken and thus is considered a tax-deferred account similar to the traditional 401(k).
The limit that one can put into both a 401(k) and a 403(b) is $18,000 a year.
The 457 is a non-qualified, tax advantaged, defined contribution plan for governmental and some non-governmental employees. Once again, like the 401(k) or 403(b) this is a pre-tax investment of money.
One difference is that there is no penalty for withdrawal of fund before the age of 55, though it is subject to income taxes..
If you have access to a 401(k) and a 457, then you can contribute $18,000 in both a 401(k) and a 457 plan for a total of $36,000. If you are over 50 you can contribute an additional $6,000 to both plans for a max of $48,000.
If you are going to be 50 years old at the end of the tax year you can contribute an additional $6,000 catch up into your 457. This is only available to governmental plans. The second catch up can occur for a total of $18,000 or equal to unused deferral limits from previous years. If you have been deferring maximum amounts of money to the 457 each year, then you can not use this extra catch up.
Government TSP- Thrift savings plan
The government TSP is a defined contribution plan for the United States civil service and uniformed services. The set up for this plan is similar to a 401(k) and has a $18,000 limit in 2017.
If you are both a civilian federal employee and a member of the uniformed services, you can have 2 accounts but the maximum in both accounts is still limited to $18,0000 or $24,0000 if playing catch up.
Catch up is available for those over 50 years old of $6,000 a year allowing for a total deferral of $24,0000.
There is no match in the civil service retirement system.
The Federal Employees Retirement System has a Agency Automatic Contribution of 1% of base pay. Matches are also made dollar-per-dollar up to 3% base pay then at 50 cents per dollar up to 5% (so you put in 5% of your pay and the agency matches 4% of your dollars + the Agency Automatic Contribution for a total of a 5% match).
Federal employees must work for 3 years to be fully vest in the agency automatic contributions.
You can start withdrawals at age 59.5 you can request “age-based” withdrawal without penalties. There are also financial hardship withdrawals.
So there you go. This article is a bit dense but it covers the basics of what a 401(k), 403(b), 457, and Government TSP plan are. Please let me know your thoughts. Which ones are you using? Do you see any benefits of one versus the other?Follow me on social media!